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Category: Education
Compounding Wisdom: Investing 101
I taught personal finance and leadership at the high school level for over twelve years. One of my favorite concepts I loved to communicate was the magic of compounding. Although great financial value is derived by recognizing the wisdom of compounding, I believe there is even greater value in recognizing the compounding of wisdom.
Could your financial success be exponentially enhanced by making wise financial decisions repeatedly over a long period?
In the months ahead, I’ll share important ideas I’ve seen result in positive financial outcomes, and give you the roadmap. The goal? Help you make wise choices at every turn in your own financial road trip. Think of it as an introductory – or “101” – guide to compounding financial wisdom.
Compounding Wisdom on Investing:
Compound Wisdom Actions
- Pay yourself first – invest every time you get paid, even if the amounts seem small, through automatic transfers to either your 401k/403b or personal accounts.
- Stretch to invest – target 15%-25% of your income to save or invest each year.
- Diversify – spread your investments across multiple asset classes to manage risk.
- Leave nothing on the table – make sure you receive the full match your company offers.
- Look out for Roth – consider the Roth 401(k) option if available in your employer plan.
- Control for fees – you can’t control returns, but you can control investment fees by investing in low-cost funds.
- Keep emotions in check – you invest for the long term, so resist the urge to trade urgently, or time the market.
- Rebalance – keep your investment allocation in balance across asset classes.
- Harvest your losses – take advantage of down markets to accumulate valuable capital losses.
- Be aggressive – as a young adult, don’t fear an allocation that is dominated by equities.
- Look under the covers – many target date funds are costly and may not be appropriately allocated.
- DIY is difficult – work with an advisor who always works in your best interest (also known as a Fiduciary).
Actions to Avoid
- Waiting to get started – your most valuable dollar invested is your first.
- Failing to sign up for employer retirement plan – start the first month you are eligible.
- Failing to earn the entire match – one of the only free lunches around.
- Investing in mutual funds with high fees – don’t be seduced by sexy short-term returns that are unlikely to persist.
- Paying penalties – don’t incur penalties by withdrawing from retirement accounts early.
- Abandoning your plan – don’t get sucked into the latest “can’t miss” stock recommendation you hear online or from a friend.
- Timing the market – invest regularly or whenever you can, as early as you can.
- Loving your company too much – monitor the risk you may incur from owning too much company stock.
Feel free to pass this along if you know someone who might benefit from the guidance and look for more from me in this monthly series.
I lead our Hillfolio level client service and planning efforts, learn more about me here and reach out if I can help you put the magic of compounding on your side.
Roth Conversion Perfect Storm
As of today, general equity markets are ~10-20% off their peak, tax rates are relatively low, and there are record amounts of cash on the sideline. This combination of variables presents an excellent opportunity for a strategy known as a Roth Conversion. A Roth Conversion is the process by which you take money in a pre-tax account (e.g. traditional IRA) and convert it to an after-tax account (e.g. Roth IRA). The potential benefits of such a change include:
- Tax-free growth inside the Roth IRA
- Tax-free distributions from the Roth IRA
- Avoiding required minimum distributions until you (or possibly you and your spouse) pass away
- Lower estate taxes
- Lower surcharges on Medicare premiums
For more information on Roth conversions, see the paper we created to provide more detail on this strategy, as well as the pros and cons of Roth conversions.
While this all sounds great, and it is, to receive these benefits, you have to pay ordinary income taxes at the time of conversion. This is a strategy worth considering if you are in a relatively low tax bracket because you recently retired and haven’t yet started receiving your Social Security or taking required minimum distributions. Even if you are in a higher tax bracket, it could still make sense because we could implement other tax strategies simultaneously. If you’d like to know the specifics around this strategy or any different ways we help clients maximize their long-term odds of success, we’d be happy to talk with you.
ESG Investing and Should You Get Into It?
Many of us may have heard of one of the latest trends in investing – ESG. But what is ESG? Is it beneficial to your portfolio returns? This article will answer these questions from my perspective as the HIG 2022 Summer Intern. But first, what does it mean?
ESG stands for three different elements of a company’s operations:
- Environmental (factors affecting the climate and natural habitat)
- Social (factors affecting stakeholders like employees, suppliers, shareholders, and the society they operate in)
- Governance (the National and International regulators of the business)
ESG is essential to know about today because investors have increasingly started to apply certain non-financial factors when evaluating companies for investment.
ESG ratings attempt to assign a quantifiable value to a company depending on the impact the company has with respect to any of these three factors. Often measured on a scale of -100 to +100 – a positive score is intended to indicate a favorable impact, and a negative score is intended to indicate a potential risk in these areas.
For example, within the ESG matrix’s social governance sector, a company may be given a positive value for increasing diversity hiring in their workforce and assigned a negative value for having no/low female representation in their upper management. In the ESG thinking, sub-par Human Resource policies could lead to potential future lawsuits, theoretically reducing the company’s future expected return and share price.
An issue with these ratings is that things can get confusing quickly. Consider, what happens if Company X scores low on the social scale due to a lack of diversity hiring but performs high in the environmental segment by lowering carbon emissions. Let’s say that Company X comes out with an excellent overall ESG score. With a high ESG score on paper, investors might invest in this “good” company, not knowing that it is scoring high in Environmental but low in Social. In my opinion, investors can be easily confused by high ESG scores, investing while blind to unhighlighted risks.
Additional questions arise about investing in an ESG strategy because there is no standard way of calculating ESG scores. There are numerous rating agencies (MSCI, Sustainalytics, RepRisk, ISS, etc.) that assign ESG ratings to companies. Each of these agencies has a different formula and factor input data and related variables differently to arrive at their score. This means that companies on different rating scales cannot be compared with one another.
So how, as an investor, can you navigate the world of ESG investing?
Ratios like EPS (earnings per share) and EBITDA (earnings before interest, taxes, depreciation) are standardized. These measures are easy to calculate and to use when comparing companies. By contrast, ESG ratios are often opaque and time-consuming to calculate, and therefore, more expensive to apply. This can result in ESG Funds being comparatively expensive to most Index funds without any indication of higher overall performance. ESG funds, because they can remove entire segments of the market – for example, fossil fuels – are often less diversified than most index funds leading to a greater concentration of risk. This could lead to lower returns and higher volatility for the investor.
Because ESG is still a relatively new concept, relatively few funds in this segment have a track record of 20 years or more to judge them accurately. So, the question remains – what do investors do If they want healthy returns but still wish to help society? They may be hard-pressed to choose one over the other and feel they must compromise on either returns or activism.
For some investors, investing to create change brings them happiness and satisfaction rather than maximizing their investment returns. ESG investing may be perfect for them. However, investors hoping to meet or exceed market returns may be disappointed.
One compromise that may leave them satisfied would be to invest in a diversified manner and use some of their income or investment returns to donate directly to specific causes or charities where they want to make a difference. This could also lead to tax benefits for the investor through using a Donor Advised fund, and the potential for higher expected returns through lower investment costs.
Another option is to support society through non-monetary means like raising awareness through volunteer work, changing individual consumption, or directly supporting activists who champion change by joining their work and helping out in their agendas.
I hope that I have provided a better understanding and more clarity on ESG practices so that you can choose the investment philosophy that best suits you!
Please feel free to call us or book an appointment if you would like to further discuss this topic.