In November the financial advisors at Ruedi Wealth Management wrote four more columns for The News Gazette’s Business Extra section. Make sure to look for the columns every Sunday, but in case you missed the columns from this past month, all four are below.
Stock Diversification: How Much Is Enough?
Paul R. Ruedi, CFP®
Almost everyone is familiar with the saying “don’t put all your eggs in one basket.” So when it comes to stock diversification, most people know intuitively they shouldn’t bet the house on one particular company. But how many stocks does it take to be “diversified.”
It is a simple question with a somewhat complicated answer. No two portfolios are alike and it is very hard to make blanket statements because a portfolio of 5 stocks that are radically different from each other could be considered more diversified than a portfolio of 20 companies that are in the same industry and subject to the same risks.
But leave it to the financial academics to try to land on a specific number for what is diversified. In the early 1970s Lawrence Fisher and James H. Lorie published a study called “Some Studies of Variability of Returns on Investments in Common Stocks.” The study found that investors using a portfolio of just 32 randomly selected stocks could reduce their distribution of returns by as much as 95% of the amount it would be reduced by owning every stock in New York Stock Exchange.
From this was born the somewhat misleading myth that a 30-stock portfolio can achieve 95% of the benefits of diversification. Later research that used more accurate measures of capturing “diversification” suggested that it would take 50 to 60 stocks to achieve 90% of the benefits of diversification.
Though these are nice round numbers that academics want to point to when answering the question of how many stocks it takes to be diversified, my experience has taught me otherwise. For example, it would be tempting to think that the S&P 500, with just over 500 companies in different lines of business all over the globe would be considered “diversified.” But all of these companies are large companies in the US, and all groups of stocks are subject to cycles. Even a group of 500 stocks can have a bad run.
This is exactly what happened during “the lost decade” when the S&P 500 temporarily lost 10% of its value from 2000-2009. Globally diversified investors had a much different experience, as strong overseas returns provided healthy growth for their portfolios. In this case, a portfolio of hundreds of stocks did not allow investors to capture the stock returns they needed to grow their wealth.
So for me, to be considered completely diversified a person must own thousands of stocks. in many different industries, all around the globe. Anything else falls short.
Key Estate Planning Documents
Daniel Ruedi, CFP®, RICP®
Estate planning comes into play upon a person’s death or incapacitation; neither of which is particularly pleasant to think about. But you can save your loved ones a lot of headaches by having certain documents in place that explain how you would like things to be handled and who should handle them should something happen to you. My experience in financial planning suggests there are four key documents people should have.
A will describes how you would like your assets distributed when you pass away. In addition to making sure assets end up where you want them, a will can also include very important things like who will raise your dependent children should you pass away. In a will you will also name who you wish to take responsibility for distributing the assets, called the executor. This is a big responsibility, so make sure the person you choose is organized and up for the task.
A financial power of attorney allows someone to make financial decisions on your behalf should you no longer be able to. A financial power of attorney allows someone to completely take over your financial life; he or she can pay bills, manage your investments, and do really anything else they need to do to manage your financial affairs. Handing this amount of control over to someone should not be taken lightly; make sure you completely trust whoever you choose.
A health care power of attorney allows someone to make medical care decisions on your behalf should you no longer be able to do so yourself. You can limit the scope of this authority, but in any case it will be a large responsibility that should be given to someone you trust. You may also want to be careful who you choose as some of the people closest to you who are emotional decision-makers may not be right for this role.
An advanced medical directive states in advance what medical care a person would like to receive, particularly with respect to life-prolonging care. Whether or not you want to be resuscitated, receive a feeding tube, or be put on a ventilator can be explicitly stated so people don’t have to guess what you would have wanted.
These are just four of the estate planning boxes we suggest people check off, but it is by no means a comprehensive list. Many people would benefit from different types of trusts, for example. If you do not have these documents in place, I’d highly recommend you talk to an estate planning attorney.
Financial Planning Tips for Expecting Parents
David Ruedi, CFP®, RICP®
My wife and I welcomed our first child in June, and after all the special milestones and nights of disrupted sleep, I now have a newfound appreciation for what new parents go through. Though you can’t completely prepare for the utter disruption to your normal life and all the other surprises of parenthood, you can take steps to prepare yourself financially. Many of these can be done in advance and can help you begin your journey as new parents as smoothly as possible.
The first thing I would recommend is to automate your financial life as much as possible. As a new parent your focus will be completely on your child, and you will be physically and mentally strained as well. This creates a recipe for things to easily slip through the cracks. So before you even have your child, I think it is important to automate any important bills or any monthly saving you intend to do.
If you don’t have an emergency fund, it is very important to establish one before the child is born. An extra person in your family means unexpected expenses are much more likely to show up and can be more devastating. Though the textbook recommendation for how much you should have in an emergency fund is 3-6 months of your fixed expenses, the amount differs for everyone, and expecting parents may be more concerned about the medical costs in their immediate future. Many people make sure to have the deductible of their healthcare plan in an emergency fund. But when a new person is born a new deductible begins for that child, and you may want to plan for this in your emergency fund.
My third recommendation is to plan for higher fixed expenses and potentially practice leaving some buffer room in your budget now. I think most people are surprised just how much extra spending is required when you have a new person in your family. You may want to start getting a sense for how much your ongoing expenses will increase and make sure you can accommodate that in your budget. If you find your budget can’t accommodate that extra spending, you may want to make some adjustments now rather than waiting until after the child is born.
These are just a few things expecting parents can do in advance to make sure their transition into parenthood begins as smoothly as possible. Make sure to read our next future columns for more financial tips for new parents.
US vs. Overseas Stock Returns
Paul R. Ruedi, CFP®
With the S&P 500 up over 25% for the year, US stock investors have a lot to be thankful for. Investors in the stocks of developed overseas countries, which have produced returns closer to 10% this year, can still be thankful but probably feel like they missed out compared to US stock returns. Investors in emerging markets, which have only returned 2% for the year, can’t be too thrilled when they compare that number to US stocks.
Investors like our clients are globally diversified, so they own all three of these asset classes. When they look at their performance of their stock portfolios relative to the S&P 500 during periods like this, it will inevitably be lower. When you look at the returns of a globally diversified portfolio relative to the hottest performing asset class in that portfolio, you will always be disappointed. That is just the deal you make when you are diversified.
But the pendulum swings both ways, and though US stocks have been the big winner lately, that will not always be the case. In fact, in what was called the “lost decade” that started in the early 2000’s, the S&P 500 produced a -9% return. A -9% return for an entire decade! But this decade was not lost to globally diversified investors, who reaped healthy returns due to the performance of the stocks in internationally developed countries and emerging markets.
Nobody can predict in advance which group of stocks will be the star performer. The only way to make sure you reap the returns you need to grow your portfolio and fund your goals is by a constant commitment to owning everything. But it can be tough to do, especially if you are always comparing the returns of that portfolio with what you could have received by investing entirely in the best performing asset class.
Although missing out on the returns from investing entirely in the winner asset class is disappointing, it is not as disappointing as guessing wrong and concentrating in the loser asset class. This would derail your financial plans. In a way, diversification guarantees you are always slightly disappointed, but never extremely disappointed.
As financial planners who have people’s most important goals in our hands, the ability to reliably reap returns that enable our clients to fund their goals is our top priority. For me, committing to holding a low-cost, globally diversified stock portfolio remains the best way to reap returns and achieve goals.
Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.