Wayne lippman a life cycle guide to investing

A Life-Cycle Guide to Investinghttp://lippmancpas.com

Walnut Creek, CA

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A life-Cycle Guide to Investing

“There are two time in a man's life when he should not speculate:

When he can t afford it, and when he can”.

MARK TWAIN, FLLOWING THE

EQUATOR

A life-Cycle Guide to Investing (Cont.)

• INVESTMENT strategy must be keyed to a Life Cycle.

• It is simple common sense to say that a thirty-four-year old and a sixty-four-year-old saving for retirement may prudently use different financial instrument to accomplish their goals.


• The most important investment decision you will probably ever make the balancing of assets categories {stock, bond, Real estate, money market securities, etc.} at different stages of your life.


• This chapter will show that: whatever your aversion to risk whatever your position on the eat-well,

sleep-well scale-your age, income from employment, and specific responsibilities in life;

go a long way toward helping you determine the mix of assets in your portfolio.

Four Assets-Allocation Principles

Before determining a rational basis for making asset-allocation decisions, certain principles must be kept firmly in mind:1. History shows that risk and return are related.

Four Assets-Allocation Principles (Cont.)

2. The risk of investing in common stocks and bonds depends on the length of time the investments are held.The longer an investors holding period, the lower the risk.


3. Dollar-cost averaging can be a useful, though controversial technique to reduce the risk of stock and bond investment.


4. You must differentiate between your attitude toward and your capacity for risk.

• The risks you can afford to take depend on your total financial situation including the types and sources of your income exclusive of investment income.

1. Risk and Reward Are Related

• The higher risk is the price one pays

for more generous returns.

2. Your Actual Risk in Stock and Bond Investing Depends on the Length of Time You Hold Your Investment.

• Your stage in the life cycle is a critical element in determining the allocation of your assets.

• The length of your holding period is important in determining your capacity for risk.

2. Your Actual Risk in Stock and Bond Investing Depends on the Length of Time You Hold Your Investment. (Cont.)

• The age and the likelihood that you can stay with your investment program not only affect the risk you can assume but even determine the amount of risk involved in any specific investment program.

• The risk of investing in stocks also decreases with the length of time they are held.


• You are reasonably sure of earning the generous rates of return available from common stocks only if you can hold them for relatively long period of time, such as twenty years or more.

• These returns are gained by the steady strategy of buying and holding a diversified portfolio.


• The most reason for investors to become more conservative with age is that they have fewer years of labor income ahead of them.

• They cannot count on salary income to sustain them should the stock market have a period of negative returns.

3. Dollar-Cost Averaging Can Reduce the Risks of Investing in Stocks and Bonds (Cont.)

• This technique is controversial, but it does help you avoid the risk of putting all your money in the stock or bond market at the wrong time.

• Dollar-cost averaging means investing the same fixed amount of money over a long period of time.


• The average cost per share is actually lower than the average of the share prices during the period when the investments are made.


• A drawback to dollar-cost average is that brokerage commissions are relatively high on small purchases, even when you use a discount broker. For that reason, it is usually advisable to buy larger blocks of securities over longer time intervals.

• The advantages of dollar-cost averaging are to join the dividend-reinvestment programs of those companies that have them.

4. Distinguishing between Your Attitude toward and Your Capacity for Risk

• Kinds of investments that are appropriate for you depend significantly on your sources of income other than those derived from your investment portfolio.

• You're earning ability outside your investment, and thus your capacity for risk, is usually related to your age.

Three Guidelines to Tailoring a Life-Cycle Investment Plan

• There are general rules• Serviceable for most individuals at

different stages of their lives• No guide will fit every individual

Three Guidelines to Tailoring a Life-Cycle Investment Plan

1. Specific Needs Require Dedicated Specific Assets

2. Recognize Your Tolerance for Risk3. Persistent Saving in Regular

Amounts, No Matter How Small, Pay Off

1. Specific Needs Require Dedicated Specific Assets

• Keep this rule in mind• Building an Investment Strategy:

Case of young couple “20” Retirement nest egg Long-term objectives Home down payment 30,000 or College tuitions for years In both cases money should be

invested

2. Recognize Your Tolerance for Risk

• Successful financial planning is more of an art than a science

• Decide what proportion should be deployed among different asset categories

2. Recognize Your Tolerance for Risk (Cont.)

• Risk tolerance is an essential aspect of any financial plan


Risk tolerance can evaluate person’s attitude toward risk: Common stocks and long-term bonds

are less risky when invested for a long time period

Accepting considerable short-term fluctuations in one’s portfolio would make no harm

September 11 is an example


• Subjective considerations play a major role in the asset allocations

• One’s portfolio depend on his/her aversion to risk

• Simple questionnaire can help in discovering person’s investment risk tolerance level

3. Persistent Saving in Regular Amounts, No Matter How Small, Pay Off

• What if one has no assets to allocate?

• Accumulating retirement savings often seems out of reach

• Don’t despair


• A program of regular savings plan each week can solve the problem

• In time it would produce substantial sums of money

• If a new thousand dollars added to the savings funds at the beginning, the final sum will be increased significantly


How Retirement Funds Can Build:What Happens to an investment of $100 a Month,Earning an 8 Percent Return Compounded Monthly

Year Cumulative Investment

Annual Income

Cumulative Income

Total Value

1 $1,200 $53 $53 $1,2532 2,400 157 210 2,6103 3,600 270 480 4,0804 4,800 392 872 5,6725 6,000 524 1,396 7,39610 12,000 1,368 6,414 18,41420 24,000 4,501 35,284 59,28430 36,000 11,422 113,594 149,594

3. Persistent Saving in Regular Amounts, No Matter How Small, Pay Off (Cont.)

• Pick no-load mutual funds to accumulate your nest egg as direct investment of prohibitively expensive

• Mutual Funds permit automatic reinvestment of interest, or dividends and capital gains

3. Persistent Saving in Regular Amounts, No Matter How Small, Pay Off (Cont.)

• Check if your employer has a matched savings plan, if it is available your nest egg will grow much faster

The Life-Cycle Investment Guide

• Wealth should always be divided into three parts:1. Third in Land2. Third in merchandise (business)3. Third ready at hand (in liquid form)

Rabbi Isaac, Talmud• Such an asset allocation is hardly

unreasonable

The Life-Cycle Investment Guide (Cont.)

• In general, make the proportion of bonds in one’s portfolio equals to one’s age:1. Mid-Twenties2. Late Thirties to Early Forties3. Mid-Fifties4. Late Sixties and Beyond


Age: Mid-TwentiesLifestyle: Fast, aggressive. With a steady stream of earnings, capacity for risk is fairly high. Need discipline of payroll savings to build nest egg.

Age: Mid-Twenties5%

20%

65%

10%

CASH

BONDS

STOCKS

REAL ESTATE


Age: Late Thirties to Early FortiesLifestyle: Midlife crisis. For childless career couples, capacity for risk is still quite high. Risk options vanishing for those with college tuitions looming

Age: Late Thirties to Early Forties5%

30%

55%

10%

CASH

BONDS

STOCKS

REAL ESTATE


Age: Mid-FiftiesLifestyle: Many still reeling from college tuitions. No matter what the lifestyle, this group must start thinking about retirement and the need for income protection

Age: Mid-Fifties5%

38%

44%

13%

CASH

BONDS

STOCKS

REAL ESTATE


Age: Late Sixties and BeyondLifestyle: Enjoying leisure activities but also guarding against major health costs.Little or no capacity for risk.

Age: Late Sixties and Beyond10%

50%

25%

15%

CASH

BONDS

STOCKS

REAL ESTATE

About Wayne Lippman

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Wayne Lippman has forty years of experience in public accounting including twenty years with Price Waterhouse, where he served as a tax partner in the San Francisco and Oakland offices. He was previously Managing Tax Partner of the Walnut Creek office of Price Waterhouse.

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