The Investment Decision Filter

Now that we’ve talked about some of the different types of accounts and their potential tax benefits of them, let’s get into what to do after you pick which type of account is best for you.

To do this, I’m going to back up just a little bit and give credit where credit is due.

Fellow financial planner, Sten Morgan, CFP?, ChFC? , has beautifully described what is called the “investment decision filter.” The general concept of it is nothing new, but the way he organizes it just makes sense.

So, what exactly is the “investment decision filter?”

Pretty much, it’s a system to break down and analyze which investment is right for you. There are 4 areas that he focuses on, and I’ll actually add another myself later, but first, let’s start off with his.

1.????? Performance. This one can be a little tricky depending on the circumstances. Yes, there are “guaranteed” types of investments out there that you don’t (reasonably) have to worry about any variation between the actual return and the return that you may expect. That being said, when most people think of investments, they probably think of the kind that can’t accurately be predicted. Yes, it’s a great idea to look at the historical returns in this circumstance, but just because some fund has had an average return of 9%, it doesn’t mean that it will continue to have that same return.

2.????? Risk. This is one that many people misunderstand. Most everyone thinks of “market risk” when they think about investment risks, but actually, there are a lot of other types of risk. There is interest rate risk that typically affects bond prices most, there’s credit risk that addresses the concern of whether borrowers can repay debts (again usually bonds and fixed income securities), There’s inflation risk that looks at whether or not the return of your investment is above the level of inflation. There’s liquidity risk, currency risk, political risk, reinvestment risk, and systematic risk and I could keep going. There are investments that offer a “risk-free rate” but in reality, there’s no such thing as a completely risk-free investment. It’s just a matter of which type of risk you’re willing to take on.

3.????? Taxes. This is one that we’ve talked about a little bit already. The vast majority of taking this into consideration comes at the time of determining the type of account like we talked about last week. That being said, depending on the type of account, there still may be more tax-related decisions to make.

4.????? Fees. There are a lot of different ways that fees can be charged and/or factored. There can be transaction fees, management fees, advisory fees, and all kinds of other things. If you’re looking at insurance products, these fees are sometimes a little harder to calculate but they are likely still there. Have you ever heard, “There’s no such thing as a free lunch”? Well, that’s true. Someone has to pay for it. It may be you, your friends, the owner, or someone else, but somehow, it has to be paid. Investments are the same way. On the off chance that there are indeed no fees, it may just be costing you potential gains, or something else. Look into this and don’t hesitate to ask questions.

5.????? Time/emotional investment. This is the one that I’m adding. I lump time and emotion into one because for this, they’re likely to go hand in hand. Putting money into your 401(k) and picking a target date fund takes very little time and emotional involvement. Especially if you choose not to look at the balance frequently. Whereas if you put money into flipping real estate, the time and emotional stressors associated with that could be much higher.

So, these are the different areas that I like to look at. No, there will probably not be an investment that provides top performance, and zero risk, taxes, fees, time, and emotional investment, and if someone promised me that perfect scenario, I would probably be pretty skeptical. But there is likely a balance that you are comfortable with.

Some will likely be more important to certain people and less important to others.

A young single is probably much less concerned about the time that an investment requires than someone with a young family with kid # 3 on the way. (Ask me how I know)

So this is again, kind of the big picture as to how to choose certain investments. We’re still not to the point of picking individual funds and to be completely honest, I’m not going to recommend anything specific. Partially because of the regulations that I’ve mentioned before, but more importantly, I just don’t know you or your situation. The last thing that I want to do is give someone advice that ends up hurting them, and if I start recommending specific investments through this platform, there’s the chance that a few people may be negatively affected.

That being said, I will continue to walk with you through the framework that I use to help you the best I can, but for specific recommendations, I would highly suggest that you talk with a financial planner of your own.

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