by As my computer was restarting, a curious notice displayed on the bottom of my toolbar- “Unknown Zone . I often feel like I’m entering an unknown zone when I speak to potential clients who have not reflected on the long-term purpose and strategy for their portfolio.
The conversations usually follow the same pattern:
Me– OK, you have $300,000 in your IRA, sitting in your money market account. Please tell me the purpose of the funds.
Client– Not sure. I was thinking about putting it in a CD. My local bank is offering 2.25% for 12 months- can you beat it?
Me– That’s certainly a good rate for 12 months. Let me ask you a few questions. Will you need income from your IRA over the next 5 years?
Me– Will you require lump sum liquidity over the next 5 years?
Me– Are you aware that in this low interest rate environment, you will be losing real purchasing power over the next 12 months, and it may be a net loss?
Me– And if you continued to leave it in cash, by the time you take your RMDs (Required Minimum Distributions), you may be losing 35 cents or more on every dollar, which would mean you would be burning through your original principal to maintain purchasing power, if you didn’t figure out a way to grow your principal, north of inflation and taxation.
Me– I’m suggesting that you consider the purpose of the funds in your IRA. If it represents the fixed income allocation of your portfolio, you might want to consider higher yielding fixed instruments such as high grade investment bonds or bond funds, over a 5-year horizon.
Client– I thought I would stay short over the next 12 months, so when interest rates go up, I can take advantage of it.
Me– I don’t have a crystal ball. But what happens if interest rates are the same in 1 year? You have lost an opportunity for higher yield. Why not consider a longer position with some of your cash? Or if we have a longer time horizon, why not consider a diversified portfolio of stocks, bonds, and cash?
Client– OK. Maybe we should reflect on the purpose and review potential strategies..
It’s very difficult to focus on investment objectives and strategies rather than investment fear when it comes to money, particularly in the current economic environment. . As Daniel Kahneman, a Nobel Prize winner in Economics, pointed out – we are not risk averse, we are loss averse.2
At the end of the day, we must give money a purpose, and implement a corresponding strategy. That’s why I created MoneyCapsulesTM: to help people think through purpose, and give their money meaning. “Making as much as I can or “finding a CD with the highest interest rate is not purpose. . Come out of the Unknown Zone, and into the Light.
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