Plan First

Many potential Servo clients I’ve talked to this year are in the same situation.  Their portfolios are extremely overweighted, or in some cases, almost exclusively invested in individual large cap growth stocks and growth stock mutual funds and ETFs.  Growth investing was all the rage for a while, which is why their portfolios look this way.  The most common investment approach for investors and advisors alike is performance chasing; they just describe it differently—“tactical allocation,” “adapting to the changing landscape,” etc..

But the growth stock boom has ended; while the Russell 1000 Growth Index of large US growth stocks averaged a whopping +17% per year for the decade through 2020, it’s gone nowhere since 2021, losing -0.3%, including over -20% this year.  The DFA US Small Value fund, on the other hand, limped to just +8% annual returns from 2011 to 2020 but has gained almost +37% since 2021 and is basically even year to date. So the chase is starting to come Servo’s way.

I might surprise you when I tell you that my advice to these prospective clients isn’t simply changing their portfolio and adopting a more diversified allocation, including small cap and value stocks. Instead, I tell them that they need to get a plan.

The Performance Merry-Go-Round

I’ve been through this cycle several times in my career now, and I know how the movie ends.  

In the absence of a plan, or without getting clear on their long-term financial goals, these investors will fire their underperforming advisor and hire a firm like Servo who manages diversified portfolios.  But they’ll start looking around again for greener pastures as soon as our balanced approach starts trailing the next hot investment segment—as it surely will at some point.  And the merry-go-round of performance chasing will continue.

My advice is to get off the merry-go-round completely, stop investing on a performance basis and instead adopt a goals– and planbased investment process.  

Goals first.  Then plan.  Only then do the portfolio decisions come in. Or “Goals, Plan, Portfolio” for short.

The Types of Plans

There are two basic kinds of plans I design today—retirement savings plans and retirement income plans.  The first is for clients who someday want to retire and live off their investments.  The second is for clients who are close to that point or who are already retired and want to live comfortably without running out of money.

So what’s an example of a simple retirement savings plan?

The Planning Process

You are a 52-year-old married couple earning $186,000 per year. You currently have $1,000,000 in 401ks and IRAs and contribute $3,000 per month ($36,000 per year). Your retirement goal is to stop working in 10 years at age 62 and live off your investments when you are eligible for Social Security benefits (you would like to retire earlier than 66, the age considered “full retirement” in terms of SS benefits).

Are you on track?  Let’s find out.

STEP 1: calculate how much income you’ll need in 10 years.

$150,000 per year (net of retirement savings) won’t buy you the same amount of things in ten years as it does today.  To preserve the purchasing power of your income a decade into the future, assuming the cost of everything you’ll spend money on goes up by about 3% per year, you will need about $200,000.  But you’re expecting to get a little more than $50,000 per year in Social Security (whose benefit increases annually by inflation), so let’s instead figure $100,000 per year needed explicitely from your investments.  Again at 3% more every year, it will take about $135,000 per year for you to buy $100,000 of things in a decade.

STEP 2: figure out how much money in investments you’ll need to generate the desired income.

We have to decide how much you can spend from your investment portfolio so that you don’t permanently draw down your principal.  Of course, the withdrawal rate needs to be well below the rate you would expect to earn on your investments to account for the volatility of returns.  Spending less than you make is the best margin of safety there is.  Let’s use 4.5% of your first-year retirement investment balance, assuming that you will increase that amount by 3% in subsequent years.  $135,000 divided by .045 brings us to a $3,000,000 portfolio.  At a 4.5% withdrawal rate, a $3,000,000 portfolio will produce the desired $135,000 of first-year retirement income we calculated is sufficient for you to retire with dignity and independence.

STEP 3: find out what it will take in future contributions and earnings to accumulate a $3M portfolio.

With $1,000,000 invested today, and the ability to add another $36,000 per year for the next decade, your money needs to grow at 9.14% annually to reach $3,000,000.  Now we have something to work with.  

The goal of investing for you is no longer to “beat the market” or “avoid losing money.”  You’re trying to get about 9% per year on your investments.  That becomes the final ingredient in your plan and informs what you should be investing in.

Look Before You Leap

“If you don’t know where you’re going, you might wind up someplace else.”

—Yogi Berra

I could say a lot more, and I will, about how to earn that rate of return.  About which asset classes have and have not, historically, worked well for plan-based investors.  And how important it is to diversify amongst those asset classes.  

But for today, let’s rest with the idea that the surest path to your financial success is to think through your goals and then craft a plan that clearly outlines what you are trying to accomplish, when you are trying to accomplish it, and what it will take. Only then should you assess your current investment portfolio in light of this plan to make sure it reflects these goals.  If it does not, change it.

The right approach for the myriad of investors today who are licking their wounds from the losses associated with an excessively concentrated portfolio of large cap growth stocks isn’t to switch to small cap value stocks.  It’s to get a plan and commit to sticking to it.  The small cap value stocks will follow.

Need help working through a retirement income plan or revisiting your assumptions?  Schedule 30 minutes with me to chat by clicking here.


Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.