Don't Confuse Having an Investment Portfolio with Having a Financial Plan
For many successful professionals, the first sign that they are doing well financially is a growing investment portfolio. Once the 401(k) balance has crossed seven figures and a handful of early investments in the brokerage account have appreciated considerably, it can begin to feel as though a financial plan already exists.
But accumulating investments and having a financial plan are not the same thing. An investment portfolio tells you how much wealth you have accumulated and how that wealth is invested. But a well-crafted financial plan is intended to answer the much bigger question of what all that money is ultimately supposed to do. That distinction becomes more important as both wealth and complexity grow over time.
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In fact, some people reach their 50s and 60s with substantial investment portfolios and surprisingly little clarity about how the various areas of their financial lives are supposed to work together. They have plenty in the way of investments, but they do not necessarily have a plan.
Earlier in your career, it can be easier to confuse investing with financial planning because the basic formula is relatively straightforward: you earn money, save a portion of it, invest those savings, and give them time to grow. With decades left until retirement, there is also more time to recover from mistakes or adjust the plan along the way.
But as retirement approaches, the situation becomes considerably more complicated. The focus begins to shift from accumulating as much as possible to determining how those accumulated assets will actually help support you once the paychecks stop. Decisions about when to retire, how much can be spent, which accounts to draw from, and how to manage taxes and investment risk all become increasingly important.
The financial services industry has trained people to place tremendous emphasis on portfolio construction, and a disproportionate amount of attention ultimately gets paid to the ideal mix of stocks and bonds, the use of individual stocks versus funds, the appropriate amount of cash, and whether a portfolio should favor certain sectors, styles, or company types. Those are all important considerations, but they are second-order questions.
Before deciding how money should be invested, it is important to understand how much needs to be accumulated, when it will be needed, and what that money is ultimately intended to accomplish. Only then can a portfolio be constructed around the goals it is meant to support.
One of the easiest mistakes experienced investors can make is assuming that better investment returns can solve a financial planning shortfall. If retirement feels underfunded, college expenses are approaching faster than expected, or an earlier retirement has become the goal, the temptation may be to take more investment risk in hopes that higher returns will close the gap.
But a planning problem cannot always be solved with better investment performance. Sometimes the better solution is to save more, spend less, adjust the timeline, or reconsider the goal itself. Taking additional investment risk may help if markets cooperate, but it may also turn one financial planning problem into two.
Another distinction that can be easy to overlook is that working with a financial advisor does not necessarily mean that comprehensive financial planning is taking place. Many investors understandably assume that because they have hired someone to manage their assets, they automatically have a financial plan. But in some cases, all they have really done is outsource the management of their investment portfolio.
There is nothing wrong with that arrangement. Investment management is a valuable service—especially for people who do not have the time, interest, or expertise to manage a portfolio themselves. But choosing investments, rebalancing accounts, and establishing an appropriate asset allocation are still primarily investment decisions. Taken together, they still do not constitute a financial plan.
For example, a person with a professionally managed $5 million portfolio may receive regular reports detailing investment performance and asset allocation while still having no clear strategy for when they can afford to retire, how to unwind a concentrated stock position, which accounts should fund retirement spending first, or how to manage taxes after leaving the workforce.
Those are the types of decisions a comprehensive financial plan should help coordinate. The investment strategy is certainly part of that plan, but it should be built alongside decisions about taxes, cash flow, retirement income, insurance, estate planning, employer benefits, debt, charitable giving, and other major financial goals.
And perhaps most importantly, a financial plan should go beyond identifying what ought to happen and instead provide a roadmap for how to make it happen. Recommending that someone diversify a concentrated stock position is only the beginning.
A plan should also address how quickly to sell, what the tax consequences may be, where the proceeds should go, and how the strategy should evolve as additional shares vest. Similarly, knowing that someone is “on track” for retirement is far more useful when there is also a strategy for where retirement income will come from, how taxes will be managed, and what should happen when markets inevitably become volatile.
A well-constructed investment portfolio remains an essential part of the equation. But the portfolio should ultimately serve the financial plan, not substitute it. The real measure of financial success is not simply the amount of wealth you have accumulated or how well it is invested, but whether that wealth is positioned to support the life you intended it to provide.
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Malcolm Ethridge is the Managing Partner at Capital Area Planning Group, based in Washington, D.C. His areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
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Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your tax and legal advisors before taking any action that could have tax and legal consequences.
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