It has often been said good financial planners help facilitate decisions for their clients. Based on my own experiences, this is an accurate statement, since I am often called upon to render wisdom regarding a particular financial transaction. I have learned that in many cases a client already knows the answer to the issue they are facing but can be trapped by emotions or asking the wrong question(s).
The key to sound decision making is to start with a "blank slate" by focusing on the goal at hand and to not be encumbered by other variables - e.g.: "If I were starting from scratch what would I do?" When it comes to financial decisions, this perspective is necessary because other factors (fees, taxes, losses, emotions, people's opinions, etc.) often distract us from making the right decision. While these factors should be considered, often they are secondary considerations. Following are a few scenarios illustrating how helpful it can be to ask the blank slate question.
The bad investment - A few years ago a client purchased an investment taking the salesperson's word on its fit for their situation and without doing their own due diligence. Now they are looking at the cost and the past and future return of the investment and are wondering whether they should hold or sell. The tough hurdle is that they invested a total of $25,000, but today's liquidation value is only $16,000 - a hard to stomach $9000 loss. When asked the blank slate question - "If you had the $16,000 in the bank would you go out and buy this same investment again?" The answer is an emphatic "NO!"
Normally, that's the solution. If the story is pretty much over on this investment, in all likelihood they should sell it now. Before making the final sell decision, it is important to calculate the tax or fee implications associated with the liquidation. If the income taxes or sales charges fees are high, a long term strategy to sell the investment might be more effective versus selling it outright. In the example of deferred sales charges, I had a client who had an investment they did not want with a significant deferred sales charge lasting another three years. Given the high penalty for selling, the client decided to wait out the next three years, but in the meantime make changes to the investment to bring it in line with their goals as much as possible.
Note: The blank slate solution works best when we know we own an investment loser, but emotionally cannot face taking the loss. It does not always immediately apply to a disciplined investment strategy. For example, if you bought a few mutual funds for retirement planning purposes, and the market went down in the subsequent 18 months, it doesn't necessarily mean a blank slate sell decision. Markets cycle and if the funds are managed well, the goal of long term growth should still occur.
The windfall - Another client received a stock inheritance and was having difficulty deciding what to do with it. The inheritance was large enough to pay off their home as well as accomplish other financial objectives, but they had a hard time with the thought of selling the stock. The same question was asked - "If you had all the cash in the bank today, would you use all the funds to buy a single stock?" As in the case above, the answer was "No". Once they thought about it from this perspective, and because taxes and fees were not an issue, they quickly decided that selling the stock was the right course of action. By asking the tax and fee question after answering the blank slate question, these factors become secondary considerations rather than drivers of the decision.
Many times with an inheritance, sentimentality can be an issue. ("My grandfather bought this stock and I don't want to sell.") This is a legitimate consideration as long as the person has counted the cost of the sentimentality.
The mortgage debt question - A third client was fortunate to have enough funds to pay off their mortgage without exhausting their savings or compromising other goals. Their inclination was to invest the funds and not pay off the mortgage. In helping them think through this situation we asked the question, "If the mortgage were already paid off would you go and take out another mortgage so you would have money to invest?" When they viewed the decision from that perspective they decided the best course of action was to pay off the mortgage and then use funds for the mortgage payments they avoided to build their investment portfolio.
The next time you face a financial decision, ask the blank slate question. Also, make sure you understand the tax and fee implications of any decision while seeking out professional advice if necessary. Next month we will look at the binary trap.
The National Planning Group of Ronald Blue & Co. is a unique division within RB&Co. that serves the everyday steward - For more information you can visit their website: www.everydaysteward.com.