When is a dollar not a dollar?

Last year, I went to a holiday party where a magician performed tricks for small groups of guests during the cocktail hour. One of his tricks involved taking a crisp dollar bill from me, after I’d written my name on it to demonstrate its authenticity later. The magician then folded up my dollar bill and tore it into pieces.

As a financial planner, I wasn’t amused at the wanton destruction of my money. But the magician moved forward with the trick and somehow put my dollar bill back together, albeit in a somewhat differently arranged manner.


I was left with a dollar…but it wasn’t really a dollar. I couldn’t spend it anywhere. And the experience got me thinking: when else is a dollar not exactly a dollar?

I came up with at least four examples, though there are likely more:

Inside of a Traditional IRA or 401k

These accounts are funded with pre-tax dollars and aren’t subject to taxes while funds stay inside the accounts. But any withdrawals are taxed at ordinary income tax rates, which are the same rates applied to wages. This means that the government technically has a claim on some portion of the funds: someone with an IRA valued at $1 million only “owns” about $700,000 – $800,000, after factoring in taxes.

Annuities with surrender charges

Insurance companies pay the people who sell variable annuities sizable commissions. Folks who buy those annuities can change their minds later and surrender the policies for whatever the value happens to be. If this happens early in the contract of the annuity, the insurance company would be out the money paid on the commission without having the chance to recoup its costs via the (often high) underlying expenses of the contract.

Enter the surrender charge. Rather being able to surrender a policy for full value, owners must pay a charge equal to anywhere between 1-10% of the surrender value for up to the first 5-10 years of the annuity, depending on the contract. As with the IRA example, a variable annuity with a stated value of $1 million may only be worth $900,000, if surrendered in Year 1 with a 10% surrender charge.

When retail investors want to sell individual bonds

Most bonds are bought and sold by institutional investors, who often trade in chunks of hundreds of thousands or millions of dollars. They are the ones setting the bond prices that people see when they view their account statements or check their accounts online. But when retail investors try to sell their individual bonds on the open market, they are often surprised that the price they receive is significantly lower than the “market” price. That’s because there aren’t many buyers for small lots of individual bonds. Values on a statement may not match values in real life.

People with too much cash stored in savings accounts

This example may be the most worst, because on the surface it looks like nothing bad is happening. Consider an account holder who, feeling scared in January, 2008, pulled $100,000 from his investment portfolio, stashed it in a savings account because it felt “safe” relative to the financial chaos going on around him, and left it there for security.

The appeal is that the savings account never goes down in value, unlike his investment portfolio that experienced a lot of volatility through the financial crises. Using the Citi 3-month Treasury Bill index as a proxy for cash, by December, 2017 the savings account had grown to $103,501, for an annual return of 0.34% with zero decreases in value.

But that’s an illusion: if the investor considered the “real” return (net of inflation) of the savings account instead of just the nominal return, things don’t look so good. From January, 2008 through December, 2017, the annualized rate of inflation (as measured by the US Consumer Price Index) was 1.61%. That’s historically very low, but so are the nominal returns for our cash proxy. When adjusted for inflation, the 1/2008 – 12/2017 annualized return of the 3-month T-bill has been -1.25%, which means that the initial $100,000 deposit can only buy $88,182 worth of stuff.

The magician’s trick was fun and games. But at Woodward Financial Advisors, we think it’s serious business to help our clients recognize the full value of as many of their dollars as we can. If you’re interested in seeing if we can help you, please let us know.

Posted in Financial Planning | Tagged ,

Paving the Way

man walking in snow

During a recent snowstorm here in Chapel Hill, I was obliged to commute to work the old-fashioned way – by walking.  It was one of those storms where the roads weren’t an option due to snow and ice, and one where most folks decided to simply stay home.  That meant I would be one of the only “moving” things in the vast white landscape, and I’d likely still be one of the only people out when it came time to end my day after work.

I bundled up and headed out the door, freshly falling snow awaiting me as I made my way through Carolina Forest and then onto MLK Boulevard. Ten minutes into my walk, I noticed that I was simply trudging through the snow – not following any clear path. I questioned my technique and wondered if taking a more focused approach would produce better results. It occurred to me that if I planned properly and made some sacrifices on my way in, such as maintaining a straight path and clearing some snow as I walked, I would be setting myself up for a much easier walk home, since I’d be returning on the very same path at the end of the day.

In many ways, my trek into work was like the financial path we pave for ourselves: the steps we take today can help set us up for future success. That’s a simple, key tenet of building wealth.

If you’re just starting your wealth building journey – or even if you are in your peak earnings years – it’s important to ask yourself if you are optimally paving your long-term financial road.

Maybe it’s time to open that Roth IRA account and set up an automated mechanism to fund it monthly.  Maybe it’s time to defer more of your salary (or even the maximum allowable) into your 401k plan and go beyond the amount for which you receive a company match.  If you’re already maximizing contributions to your tax-deferred accounts, why not open and fund an after-tax investment account?

Just as my focused morning walk through the snow required discipline, your financial decisions will likely require some sacrifice. We each must evaluate our overall financial situation before moving forward.  But paving the way today often leads to great results down the road. This financial planning in advance and longer-term commitment will:

  1. Supercharge your asset growth and let you make the most of compounding.
  2. Provide you greater flexibility if you need or want to retire from your full-time job.
  3. Reduce your need to take excessive financial risk with your assets.

When it was time for me to head home and “retire,” I followed my previously paved path as I walked comfortably past 12-inch snow drifts that rose to my right and left, thankful that I had done the hard work earlier on.  Whether you’re starting your wealth building journey or are decades into it – contact us at Woodward Financial Advisors if you’d like to learn more about our services to help you build your wealth and make the most of your financial resources.

Posted in Financial Planning, Investing, Retirement Planning

Trust the Process, Part 2: Portfolio Rebalancing

Flow Chart

In October 2017, we shared our process for when a client requests a cash distribution from their accounts. In this second post of the “Trust the Process” series, we’ll talk about the steps and decisions that go into portfolio rebalancing.

At its core, the concept of rebalancing is simple. Start with a target percentage allocation of each asset in a portfolio, and as asset values change, periodically make trades so that the portfolio doesn’t drift too far from those targets. Essentially, you’re selling portions of assets that have gone up in value and using the proceeds to buy assets that have either stayed the same or have decreased in value. Rebalancing is a great tool to reduce portfolio volatility and, depending on the nature of the underlying assets, can even lead to increased returns.

In practice, things get more complicated. Investors must establish a rebalancing philosophy by answering some important questions, such as:

  • How frequently should one rebalance?
  • Should an investor always rebalance back to their target weights, no matter how much or how little deviation there is from a target?
  • Should rebalancing happen at the account level or across all an investors’ accounts (i.e., at the “household” level)?
  • How should an investor think about taxes, since at some point he or she may have to sell something in an after-tax account that’s worth more than its cost?

These are the sorts of questions that generate content for doctoral dissertations and academic journals. Based on our review of that research, Woodward Financial Advisors has settled on a philosophy that can be summed up as, “Check often, but trade infrequently.”

To start, we construct portfolios at the household level. That allows us to put less tax-efficient asset classes (like taxable bonds and real estate mutual funds) in tax deferred accounts, so that clients don’t have to pay taxes on any interest generated throughout the year.  We call that “asset location.”

Next, we establish target weights for each asset class. But rather than blindly rebalancing back to these target weights at every review, we establish “tolerance bands” of 20% around each target. Think of those bands as “guard rails.”

Rebalance Picture

For example, if we thought that Asset Class A should make up 10% of a portfolio, we’d be ok if that asset class made up anywhere between 8% and 12%. But if it strayed above 12%, that would be our signal to sell a portion. These bands help reduce the total transactions and associated costs when rebalancing.

If we need to make trades in taxable accounts, we do so with an eye on taxes. We’ll check to see if there are investment lots that we can sell at a loss or, barring that, at a reduced gain. We may also sell other asset classes that might not need rebalancing if they can be sold at a loss to offset gains, provided we can do so without selling so much that we violate the tolerance bands. And due to our “household” approach to portfolio construction, we may sell an asset class in one account but buy it back in another, so that we keep the whole portfolio in balance when all the transactions are done.

We review portfolios multiple times throughout the year for rebalancing purposes, in addition to using the tolerance bands as our guides whenever clients request cash or add cash to their portfolio. Since some of the asset classes we use can be volatile on their own, these multiple checks help us catch when some of those asset classes go outside of their bands. If we only rebalanced once or twice per year, we’d miss those opportunities.

Our rules-based, disciplined approach prevents emotion from guiding our actions. And the documentation of and adherence to the steps in the process result in a consistent client experience.

Posted in Financial Planning, Investing

Who Knew…

It’s that time of the year when the investment media trots out its predictions for 2018, seemingly coming to our aid with headlines of “What you need to know in 2018” and “Invest in ____ if you want to be successful.”

We’re not big on investment prognostications or reactionary investing based on a change in the calendar. We prefer an investment philosophy that works consistently under any set of conditions.  With that in mind, we offer up the Woodward Financial Advisors reactions to some fairly common investment headlines making the rounds this time of the year:

Hedge fund “X” is moving into currency trading.

Better them than us. We’ll just focus on investing globally and letting currencies do what they will. That will most likely lead to long term success without over-complicating our investments and costing more than it should.

The Federal Reserve may raise rates this year.

Got it. They may, but they may not, and it doesn’t matter. Even if they do raise rates, we’re not going to alter our bond investments or our stock investments.  Did you know the Federal Reserve meets about every six weeks? That’s a lot of meetings to follow and worry about over an investment lifetime.

Company “A” beat earnings and its stock is rising

Okay. We probably own it since we invest in mutual funds with thousands of holdings. If so, great. If not, we own plenty of other stocks that are advancing.

Company “B” missed on earnings and its stock is falling

Okay. We probably own this one too. If we don’t, then we dodged one. And even if we own it, it will be a very small portion of our balanced portfolio, so we’re not going to get bent out of shape over it.

Here’s how to play the upcoming earnings season.

We don’t need or want to do this. This is our long-term money we’re talking about. It’s not something to play around with. We have a well thought out and diversified portfolio built for the long haul.

Big changes in health care are on the way, invest in this…

We might consider changing our health care plan, but we’re not going to change our investments.

Some bank or famous investor is betting big on…

Let them make bets of whatever size they wish. We’re not making bets on a stock or sector regardless of who else is.  We’re not going to be swayed from our strategy by some famous person(s) who made a media appearance.

These red-hot tech stocks delivered triple digit returns – buy them now.

We’re not going to chase performance. And besides, shouldn’t we have bought them before they went through the roof?

First quarter profits are up for company “ABC” – buy it.

Noted. Although, this seems like a pretty short time frame over which to evaluate a company, no? Ideally, we like to measure performance over multiple years or even decades.

Some stock market indicator says that it’s time to sell.

And we say that it’s time to stay invested, rebalance and think long term. We’re not going to try to dodge the next downturn by jumping in and out of the markets. Plus, that indicator has said “sell” for five years and been wrong.

The portfolio you should have in an uncertain market is the…

Same one that we should have in any other type of market.


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