I sensed an admonishment looming. “While I know I should leave my electric toothbrush in one place, I routinely move it around my mouth,” I admitted to the dental hygienist. She looked at me sorrowfully—the admonishment arrived as expected. She then told me I am doing my gums and teeth no amount of good by this tactic and that I need to be more mindful to get the greatest benefit. I nodded, clutching my dental goodie bag upon leaving.
On my way out, it occurred to me that, similar to brushing your teeth, meaningful financial planning is about knowing when to be active and when to be passive. Being active is not always the correct answer, and being passive can certainly do more damage than good in specific situations. When you hear the words “active” and “passive”, you likely think of an investment philosophy. But real financial planning goes far beyond your investments and your methodology; it encompasses the breadth of everything related to all financial-related decisions and actions.
Financial planning includes:
- Cash Flow Management (Budgeting)
- Risk Management (more than market risk)
- Income Tax
- Retirement Planning
- College Cost Planning
- Elder Care Planning
- Estate Planning
- Investment Planning
Each aspect of financial planning requires a level of involvement and action that is appropriate to your time of life.
Cash Flow Management is one of those areas that demands attention from those who need to keep their eyes on where their dollars are going. Your accumulation targets are best achieved by living within the boundaries appropriate to your goals. There are many automated programs that assist in compiling the numbers; but your time is essential to check, update and adjust these numbers as often as possible.
Risk Management is one of those areas that typically doesn’t require a great deal of activity or attention. The big work of assessing risk is performed up front with annual checks or life event triggering adjustments. Risk management requires understanding how much risk you wish to leverage to an insurer. Where does the potential liability outstrip the cost of insurance? For example, you set your homeowners, auto, umbrella and medical insurance limits based on a deductible, co-insurance or other benefits that transfer risk.
Income Tax planning typically requires a heavy commitment of time. If your situation is fairly simple, you’ll need to review taxable events during the year and match them up against your withholding—that should do it. If you have a more complicated scenario, it is important to work with a CPA or Tax Attorney who can provide advice and prepare tax projections. No one likes surprises on April 15th.
Retirement and College Cost planning actions are time-oriented and mapped out by your goals and expectations. Once your targets have been established, an annual review should suffice without much heavy lifting. While retirement dates typically aren’t fixed, college enrollment is, and therefore a more robust awareness of progress towards the funding goals is important. The further away you are from the triggering date, the more latitude exists. When the date is not known, more attention is required.
Elder Care and Estate Planning are vital parts of your financial plan. Tax laws and personal needs and desires are center-stage in the preparation of strategies that bring peace of mind and success. Changes in the law or your desires could necessitate action.
Investment planning is an area that many believe requires robust action and attentiveness. The investment world has been arguing the merits of an active vs. passive approach since the advent of index funds. My conclusion: The decision should be based on clear research, a thorough understanding of costs (both internal and external) and the risk associated with each methodology. Research done by Professors Eugene Fama at the University of Chicago and Kenneth French at the Tuck School of Business at Dartmouth College have presented findings that suggest strong returns of actively managed mutual funds is more due to luck and not skill. If Fama and French are correct, your investments is not the place to be active.
Holding my buzzing toothbrush to the side of my molars this morning, I felt the urge to saw away at the side of my teeth. I resisted the impulse, reminding myself how important it is to understand when to be active and when to be passive.
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