The Two Calculations Every Investor Needs to Make

KNOWLEDGE-QUOTES-An-investment-in-knowledge-always-pays-the-best-interest.-Benjamin-Franklin

Striving for financial independence – and the peace of mind that comes with it – creates uncertainty and anxiety in many investors.

There is so much you cannot control: GDP growth, economic policies, interest rates, inflation, corporate earnings, consumer confidence, commodity prices, currency fluctuations and stock market gyrations to name just a few.

However, at The Oxford Club’s Private Wealth Seminar in Beaver Creek, Colorado, last month, I told attendees not to despair.

The crucial steps are straightforward and within your control.

For example, the future value of your portfolio will be determined by these six factors:

  1. The amount you save
  2. The length of time you let it compound
  3. Your asset allocation (how you divide your portfolio up among stocks, bonds, real estate, cash, etc.)
  4. Your security selection
  5. The investment costs you incur
  6. And the taxes you pay.

To maximize your returns, you need to save as much as you can, let it compound as long as you can, asset allocate properly, diversify into market-beating securities, minimize your annual expenses and tax-manage your portfolio to keep the IRS at bay.

If you’re not focused on these six primary factors – all well within your control – you are taking your eye off the ball.

The problem, however, is that these steps are merely the answer to two important questions that many investors haven’t given adequate consideration.

The first is “How long am I likely to live?” The second is “How long is my portfolio likely to last?”

Some will shrug and say they can’t possibly know. But you can get an awfully good estimate. It requires two calculations: your life expectancy and your portfolio’s life expectancy. Both are quantifiable.

Let’s start with your life.

No one knows exactly how many days they’ll spend on this little blue ball, but actuaries have spent centuries learning how to make a good approximation. You don’t have to visit a life insurance company to get an estimate, however. All you need is a Life Expectancy Calculator.

There are several good ones online. And they’re free.

A decent calculator – like this one offered by the Wharton School – will ask your age, gender and marital status (because young people tend to live longer than old people, women tend to live longer than men and married folks live longer than single folks).

But that’s just the beginning. It will also ask about your height, weight and fitness level, your educational attainment, your income bracket, your personal medical history, your family medical history, your tobacco and alcohol use, and even the number of miles you drive each year.

When you’re done, it spits out a specific number. (Mine was 90.) Subtract your current age and you know roughly how much sand is left in the hourglass.

Some people find this calculation dispiriting. I don’t.

To the contrary, it’s empowering. Partly because you can fool with the inputs and see how much longer you might live if you put down the coffin nails and the television remote. But also because this calculation tells you how long your investment portfolio needs to last. (You don’t want it to kick the bucket before you do.)

True, you could step in front of a bus tomorrow and the whole exercise would have been for naught. But before you can handle your serious money in a serious way, you need to know approximately how much time you have left on the right side of the daisies.

With this number in hand, you next need to estimate how long your investment portfolio will last. Again, many will say they can’t possibly know.

Not with 100% certainty, of course. But you can get a very good idea. However, that requires another important calculation – one that, in my experience, not one investor in 50 has made.

I will discuss it in detail in my next column.

As someone who has spent the last three decades as a research analyst, portfolio manager and financial writer, I can assure you that if you complete these two important calculations and focus on the six steps above, you will have done more than what 99.9% of investors have to secure an economic future and reach financial independence.

And isn’t that what all your financial striving is really about?

Good investing,

Alex

Source: Investment U

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