Family Investment Center
Dan Danford is a gifted communicator. He has written hundreds of articles and several books. He has taught classes for high school, college, and community groups. He speaks often and served as commentator for a local ABC affiliate television station.
Dan founded Family Investment Center in 1998. In total, he’s been a successful senior officer in five different banking or investment firms since 1984. He earned a Master’s degree in Personal Finance from Kansas State University and an MBA from Northwest Missouri State University. Today, Family Investment Center manages well over $200 million for clients in a dozen states.
Dan is quoted extensively about investing. He’s written for or been quoted in the Wall Street Journal, New York Times, Chicago Tribune, Kiplinger’s, U.S. News & World Report and dozens of other newspapers, magazines, and media outlets.
Dan has served in numerous leadership positions for civic and professional boards including the Missouri Western State University Board of Governors and as treasurer of the St. Joseph Area Chamber of Commerce. He was Chairman of the Friends of the Free Clinic, a support group for the Social Welfare Board in St. Joseph.
Dan has been president of the Missouri Western State University Alumni Association and was honored in 2003 with the Missouri Western State College Distinguished Alumni Service Award.
MS, Personal Finance, KSU
BS, Marketing, MWSU
Assets Under Management:
Dan Danford / Family Investment Center
Putting bonds or bond funds in tax-free accounts is a very common suggestion. But I think it is kind of dumb. Or, at the very least, it places focus on the wrong thing.
It is always a good idea to consider taxes. But my experience says that many people place too much emphasis on taxes, to their detriment. Municipal bonds are a great example of this … many people who buy them are in lower tax brackets where the interest rate spread doesn’t really work. But they are so strongly opposed to paying tax that they buy them anyway! (Of course, the broker selling them couldn’t be happier.) They’d be better off after paying taxes on taxable interest.
So, let’s assume bonds are paying 3% a year. It’s right that you’d pay annual income taxes on that interest in a brokerage account. Truthfully, though, that’s not a lot of tax because it’s not a lot of income. Today’s rates are lower than usual, but a diversified investment portfolio will nearly always beat them on a long-term basis.
Put them in a 401(k) or IRA and you’ll save that bit of tax every year. But you’ve also limited the tax-deferred compound growth of your 401(k) or IRA to just 3% a year! The opportunity cost of that choice is huge. You’ve given up compounding (tax-deferred) at a much higher rate for decades. Compare the compound growth of $50,000 for 20 years at 3% to 20 years at 6%. The difference is over $30,000 in growth. And 6% estimated returns could be low for a diversified portfolio.
It is also true that the extra $30,000 will be subject to taxes when withdrawn, but those can be mitigated though good decisions when that time comes. In fact, 401(k) and IRA money stays in tax-deferred status for decades and decades.
The point of this entire discussion is to shift your thinking from tax savings to opportunity cost. Both should be considered in reaching solid investment decisions.
Discount cash flow models are important, but they aren’t the only factor in stock price (thus market cap). Many, maybe most, people wouldn’t read or understand a discounted model if you handed it to them.
Of course, discount models are based on estimated future cash flows, so those estimates can be wrong. They are produced by some analyst, not the company. Plus, the cost of capital and growth rates are – at best – educated guesses. A public company’s revenues should grow from year-to-year but there is no assurance of that. But, over time, rising cash flows and revenues do bring rising stock prices.
People buy stocks based on anticipated growth and opportunity, too, and those are rarely shown in the numbers. And the perceived opportunity can be very distorted. Stock prices and market cap reflect the current value set by thousands or millions of buyers and sellers. Each does their own analysis. Emotion plays a bigger role than you might expect.
Much about investing is situational. Calls to my office are usually prompted by some financial event. Perhaps a divorce, death, retirement, or change of job. That is not always the case, but something often spurs the investment interest.
I’ve noticed over many years of helping people that finance isn’t a priority for most people most of the time. In fact, most people are busily managing their family, jobs, recreation, and time … if they have money to fund those activities, investing probably isn’t on their radar. Until some financial event happens.
Truthfully, there’s not much value in approaching those people before the right moment because their attention is necessarily elsewhere. I compare it to certain kinds of advertising; snow tires don’t attract much interest in July, but those days surrounding the season’s first snow are magic for retailers.
One last point. A small segment of people love finance and investing. Those people tune to CNBC, and read every book and article they can find. Finance and investing is a hobby to them and their interest never wanes. A lot of advisors have this level of interest, too. My observation is this: it’s really hard to stimulate that level of interest in others. You may wish that family and friends cared that much, but most of them aren’t going to care until they encounter a financial event.
An analyst’s “target price” is his/her best estimate of a stock’s future price. Since the stock market is an auction where buyers and sellers transact business, the analyst is trying to determine a solid estimate of future price based on company financials, industry trends, and economic factors.
Analyzing stock prices is not an exact science. Ten different analysts will arrive at ten different target prices depending on each one’s weighting of various factors. For traded stocks, they should each be starting with the same set of public financial data, but that entails a hundred or thousand data points for each stock. Plus, each analyst will apply their own process, experience, and judgment to that data.
Additionally, at least part of a stock’s value lies in future (estimated) data. Financial records necessarily look backwards, but the value to a new buyer lies in the company’s prospects. Will sales grow faster or slower in the future? Are margins in the industry rising or shrinking? Does the company have any product innovations in the pipeline? How about their competitors?
So, setting a target price is a judgment call. An informed analyst weighs all the past and future data with their own personal knowledge of the company and industry. From this, they set a target that they expect sometime in the future. Buyers or sellers can then use this target for their own decision-making about the stock.
Let’s say that a certain analyst sets a target for ABC stock at $25 per share. The stock is trading today for $20 per share. If you think this analyst is credible, then you might choose to buy ABC because you could make $5 per share (a whopping 25%) when the share price hits that target (again, timing of that price change is an estimate, too). Or if you question this analyst’s credibility, you can search to see what other analysts estimate for ABC before deciding.
An analyst sets the future target price with little regard to the price today. So, they might set a target price for ABC at $15. If you find that analysis credible, you’d probably decide to wait before buying (until the price falls to $15 or less) or sell if you already own it. Again, this is just one person’s judgment about the future price. You can use the information however you choose.
Importantly, really importantly, no one knows what will happen next with stock prices or any company. The fact that someone is an analyst following a stock does not make them right. They are simply an informed party doing their best to understand the company and landscape. Even the best analysts will be wrong sometimes.
As an investor, you are the final decision-maker. Learn as much as you can, choose credible people or companies for information, and exercise your own judgement when buying or selling. There are a million moving parts and it is impossible to predict the future.
That's a lot of money, and I worry about your situation. There are a ton of people who would like to advise you about investing $4 million. Unfortunately, few of them have experience with investing large amounts of money. This is a science and few casual investors (friends, relatives, or colleagues, I call them FRCs) or retail professionals (insurance agents, storefront brokers, or local banks) know how to devise, construct, or monitor a sizable portfolio. In the best case, they'll refer you to competent others; in the worst, they'll botch your investments as they learn. I think it is imperative that you find an advsory firm or trust bank that is competent with portfolio science. Ask your CPA or attorney to help research firms that have experience and exertise with large portfolios.
As for spending some of the money, I wholeheartedly recommend it. I created a little word device for situations like yours. I tell people getting a windfuall to blow it, mow it, and grow it. First, have some fun and do something you want. What's the point of money except to enjoy it? Take a chunk, spend it on something fun, and remember that as a tribute to the circumstance creating the windfuall. Next, spend some money to take care of money issues in your life. Budgeting, maybe, or enroll in a community college personal finance class. Hire someone to help with the portfolio, and take care of any maintainance issues necessary to succeed. Last, grow it. Invest to grow the portfolio and/or your own abilities. Personal growth is a great avenue and I suggest anything from professional certifications to guitar lessons ... you are very young and you can enjoy the fruits of growth investments for decades.
You face some remarkable opportunties with an inheritance like this. Best of luck to you.