Many economists will make announcements that “this time is different” when trying to explain why markets or economies begin to divert from their historical averages. They try to explain why home values can appreciate indefinitely (think housing crash of 2006-07) or why technology companies don’t have to be profitable (think tech wreck 2000.) This particular writing has nothing to do with the economic times or market conditions. Rather, it is all about you and where you are financially.
The financial services industry communicates with its customers via constant data communication through monthly and annual statements. Whether it is through the custodian’s website or paper copies sent to you in the mail, you search out data to find out how you are doing. That search and determination is all relative. How are you doing compared to the indices? How are your accounts performing compared to your friends’ accounts? Interesting comparisons perhaps; but these snapshots of data provide no meaningful guidance to improve your long-term financial journey.
In truth, it is different this time because you are different. We all progress through a natural financial cycle called the phases of finance. When we are young, we begin to save money. For some of us, this phase begins at a younger age than others but we must all begin with that first step. We call this the accumulation phase. It has two primary areas of focus: saving the proper percentage of our income and investing in a tax-diversified manner. Notice the rate of return was not mentioned as it matters least when we first start out.
The second phase is preservation. In this phase, the savings we have accumulated matter more than the money we are adding each year. This is truly where the average return matters most. Keep in mind that in order to get the average return of any investment or fund an individual has to be there in the beginning of the period, the middle and the end! Most investors don’t have the discipline to sit through periods of market volatility and that is why the majority of mutual fund investors receive less than the stated average return.
The final phase is distribution. This is the phase where we convert our assets to income and it is perhaps the least understood part of the investing process by individuals and professionals alike. Mistakes at this time are often irreparable and usually avoidable. During distribution the tax treatment and the volatility of the assets being distributed become the focus. It is easy to illustrate how lower returns with reduced volatility can trump higher average returns in the distribution phase.
Your statement comes monthly, and if you are like most people, you look at the number the same way every time. We all want growth for certain. We all want stability and financial soundness. As an investor, you must learn that it is different this time because you have changed! You are progressing financially and you need to look at the data accordingly.
Joseph “Big Joe” Clark, whose column is published Saturdays, is a certified financial planner. He can be reached at firstname.lastname@example.org or 640-1524.