2013-12: December 2013 What Works in Personal Finance Newsletter

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What Works in Personal Finance Newsletter

December 2013 Newsletter

Concentrated holdings increase portfolio risk

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A significant portion of a portfolio may sometimes become concentrated in a single investment entity, which dramatically increases the overall risk of the portfolio. For 99.9+% of investors, there is absolutely no good reason to maintain any high level of concentration in any individual security. Immediate steps should be taken to reduce the exposure to under 1% of a personal portfolio.

How many failed public companies like Lehman Brothers, Enron, and WorldCom do investors need to see crash and burn, before they realize that excessive concentration often does not pay and can lead to very significant personal financial peril?

Of course, multiple millions of people think that they work for a “good company” with a stock that will become more valuable, and they want to own a part of their employer. For some of these loyal employees, this has worked out, but for others it has not turned out so well. Of course, this could not happen to you and to your company, right?

You must stay invested to earn market risk premiums

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The securities markets pay risk premiums. You have to have your money invested and at risk to be paid a risk premium. Attempting to avoid risk or losses by jumping in and out to “time the markets” does not work. Scientific finance studies demonstrate the both amateurs and professionals are lousy at market timing.

Historically, U.S. securities markets have paid substantial risk-adjusted returns or risk premiums to investors. While risk premiums have been substantial, they have occurred irregularly. There have been intervening periods of losses, some of which were substantial and grinding on investor psychology.

To earn market risk premiums, your assets must be invested and exposed to potential risk or loss. The more risk you can tolerate, then the higher your potential return and perhaps the rougher the investment road you may travel. Those who have better emotional tolerance for asset volatility can more easily weather market sell-offs.

Asset Allocation and Investment Asset Tax Location

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This article discusses personal investment portfolio asset allocation and some considerations about where to hold different classes of financial assets from the standpoint of more optimal taxation.

As you move your cash, bond, and stock financial assets into lower cost, more broadly diversified investment mutual funds and/or ETFs, you should also consider how to “locate” your investment asset allocation with respect to more optimal taxation. This article also discusses some ideas about where and how to hold your cash assets and how to make emergency cash available.

Living Expense Tracking Methods

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Many people do not track their living expenses and do not understand the magnitude of their consumption. Failure to monitor your consumption expenditures means that they are flying blindly regarding their future finances. If you do not understand how much you spend and how much you are saving and investing, you simply do not have a financial plan. This situation dramatically increases your family’s long-term financial risk.

I strongly recommend that people adopt some form of expenditure tracking to increase their understanding of their annual ordinary living expenditures. A variety of manual and/or automated methods can be used to track expenses.

In general, there are at least three primary methods of tracking ordinary living expenses on either an annual, quarterly, or monthly basis. These methods are more or less time consuming, and each provides differing levels of information about your consumption. Furthermore, these methods can have ancillary efficiency benefits to your ongoing family financial management process.

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