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February 21, 2015

Winning The Game of Financial Management

Financial management is, in part, a game. It comes not only with certain rules, both also with incentives and penalties. There are rewards for making astute choices, though doing so can require both spending time with the “rulebook” and thinking thorough the various options.
My wife and I going through this right now with a vacation we’re planning. I have miles on American Airlines and she has a large number of points on a credit card. In trying to figure out the best way to use both, one thing has become clear: We need to reevaluate our choices of credit cards. If you truly understand your spending patterns (meaning the types of businesses you mostly spend money at), it is possible to more efficiently make use of credit card rewards and thereby boost your savings rate.  What I haven’t done yet—and doing so will require some legwork—is to figure out whether it’s better to get airline miles or cash back. I do think the answer partially depends on how much one travels. Of course, the big key is to never carry a balance from one billing cycle to the next. (For those who do carry credit card debt, balance transfer offers can lessen, but not eliminate, the penalty of doing so.)

The game extends far beyond credit cards. As individual investors, we’re faced with making decisions that can directly impact our net wealth. The financial industry, for its part, often complicates matters by engaging in gamesmanship. Tools for trading more frequently, products designed to get you take on more risk then you should and high expenses are all traps we face. There are also big decisions we have to make at retirement, including claiming Social Security, selecting a withdrawal rate and deciding what our new lifestyle will be like.
I’ll start with retirement, because it’s a big decision with potentially significant consequences for making the wrong choices. Everything else being equal, delaying claiming Social Security benefits until you reach age 70 increases your lifetime income. There can be reasons to claim earlier, such as spousal benefits, involuntary retirement or the expectation that you won’t live past your mid-80s. Similarly, while there are reasons to retire earlier, working until age 70 can also boost the amount you will be able to withdraw from your portfolio.
Then there are withdrawal rates. Taking out too much money early in retirement can leave a person broke late in life. The guideline of limiting withdrawals to no more than an inflation-adjusted 4% of one’s portfolio balance at retirement continues to largely hold up. It’s possible to somewhat tweak the rate up or down, but most studies suggest withdrawal rates close to the 4% figure.
The biggest challenge is what do with one’s savings. This is a challenge facing investors of working age and in retirement alike. It’s also where the financial industry most engages in gamesmanship. It’s largely to each company’s benefit not only for you to have your accounts with them, but also for you to spend as much as possible on fees and expenses. This is where it pays off to put in effort to determine what services and features you truly need as well as what investments and products are best suited for your goals, financial situation and tolerance for risk. A true do-it-yourself investor should seek out the firm(s) with the lowest-cost fees that provides the necessary services (e.g., research reports, screeners, etc.) Those seeking assistance should view the advisory costs in light of the benefits being received. An adviser who keeps you on track to achieve your goals can be worth every dollar spent.
If you don’t mind a little added complexity, using more than one firm can make sense. An example would be using one brokerage firm for stock and ETF trading, another for purchasing annuities, and perhaps a different company for your banking and short-term savings. The right number depends on where you find an acceptable balance between getting the best deals and not having too many accounts to monitor.
What you want to be wary of are the tools the financial industry has developed to get you to trade more frequently. Mobile trading applications, including price alerts, can seem convenient, but they also lull you into making more reactive decisions. Even though it may sound counterintuitive, taking longer to make a buy or sell decision can lead to better profits if doing so helps you be more mindfully engaged with the process.
These factors are why you should always know what the fee schedule is. This is one area where your efforts can save you money over the course of many years. For example, some brokerage firms will let you reinvest dividends at no charge, whereas a company’s direct reinvestment program may come with costs. There can also be charges for paper statements, calling to speak to a broker or wiring funds. If you know what the fee schedule is, you will be better positioned to figure out how to potentially get around it.
The best way to win the game of finance is simply keep your costs low and avoid the big mistakes. Every dollar you don’t spend in expenses is a dollar you get keep and grow. So spend your money wisely and ensure you are getting enough value to justify the dollars spent. At the same time, realize that the biggest factor hurting many investors’ portfolios is often the behavior gap—the money lost to bad decisions. The more you can stay both disciplined and focused on the long term, the better off you will be.
The Week Ahead
Dow Jones industrial average component Home Depot (HD) will report earnings on Tuesday. Joining it will be more than 40 other members of the S&P 500, including fellow retailers Lowe’s (LOW) and Target (TGT) on Wednesday.
The week’s first economic report of note will be January existing home sales, released on Monday. Tuesday will feature the December S&P Case Shiller home price index and the Conference Board’s February consumer confidence index. January new home sales will be released on Wednesday. Thursday will feature the January Consumer Price Index (CPI) and January durable goods orders. Friday will feature the first revision to fourth-quarter GDP, the University of Michigan’s final February consumer sentiment index, the February Chicago purchasing managers index and January pending home sales.
Fed Chair Janet Yellen will give her semiannual testimony on monetary policy to a Senate committee on Tuesday and to a House committee on Wednesday. Atlanta Federal Reserve Bank president Dennis Lockhart will speak publicly on Thursday. New York president William Dudley, Cleveland president Loretta Mester and Federal Reserve vice chair Stanley Fischer will speak publicly on Friday.
The Treasury Department will auction $26 billion of two-year notes on Tuesday, $35 billion of five-year notes and $13 billion of floating two-year notes on Wednesday, and $29 billion of seven-year notes on Thursday.
About The Author - Charles Rotblut, CFA is  the VP and Editor for American Association of Individual Investors (AAII).  Charles is also the author of Better Good than Lucky.  (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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