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My Take On “What I’ve learned after 14 years at the most ‘depressing’ job in America”

This article has been shared widely since it was published a few days ago.  I appreciate the perspective the author shares as a journalist who’s covered personal finance topics for 14 years.  He has had to share many sad truths with his readers about how the majority of Americans are not saving enough for retirement, and how an increasingly complicated field of products and services leaves many Americans confused.

I agree with many of his comments and a lot of his lessons.  I have a different takeaway from the article.  It’s more proof that personal financial planning is more challenging than ever before and a trusted financial advisor is needed to help navigate the obstacles and set a proper course for people to reach their goals.

With all the tools and products that exist in the market, it is now possible to build a truly customized one-of-a-kind plan to help a client reach his or her financial goals.  Annuities may be a bad idea for most investors, but for some, an annuity is exactly what is needed.  Same goes for a reverse mortgage.  Most people will never have a need for one.  But for a select group of people, it may be a much-needed lifeline.

When someone gets their paycheck, they have lots of decisions on how to spend it.  As a society, we spend too many of those dollars in the present and save very little for the future.  Americans, in general, opt for things like a daily cup of coffee without realizing how much it adds up in the future ($3 a cup every workday for 30 years totals $23,400).  They make these decisions all day long without realizing the kind of impact this has on their future.

This, again, is where a financial advisor can help.  We often help to coach our clients in deciding how to pay off debts and nudge them into saving a little more for retirement.  In a sense, we are advocating on behalf of their future self.  And when market volatility returns, we are there to coach them to stay the course with their investment strategy.

To summarize, Roberts article provides a great perspective. I just wish he talked about how a financial advisor can help to provide guidance on many of these decisions that most Americans struggle to solve on their own.

Following the Herd

The following post comes from Edward, our summer intern.  He has been helping me prepare for a presentation later this summer on behavioral finance.  What follows are some really interesting comments about how our own behavior can affect our financial decisions… and in some cases it results in a negative outcome. Specifically, his comments deal with a very common behavioral concept called herding.

The human brain is hard wired to agree with the majority of a group in most situations. Whether it’s a multiple-choice question, advice, or even the stock market most people tend to agree with the majority. In 1951, Solomon Asch had created an experiment to test natural conformity. In this experiment he told the subjects they would be taking part in a vision test. A group of participants were gathered in a room, shown an image and asked very simple questions.   They were then shown the image below.

The question asked was “which line on the right matched the line on the left?” Despite the simplicity of the question, 32% of the subjects actually gave the wrong answer.  What the participant’s didn’t know was that everyone else in the room were in on the experiment.  Despite a room full of “participant”, there was actually only one person taking the test.  These “participants” were told to provide a wrong answer.

The actual participant would look around the room and see everyone had come up with a different answer. Then the participant would follow the lead of everyone else and copy their answer. Even though the other lines were off by a few inches, one out of every three would follow along with the crowd. One of the main reasons for their decision was social pressure. Most people wish to be accepted by the group. If they chose differently than the group then they might begin to feel like an outcast.

How does this relate to the market? 

Many people believe that a large group couldn’t possibly be wrong. Even if you are 100% convinced that the group is wrong you might still feel like following the herd is the best option. In the 1990’s many investors were turning toward Internet related companies. However, many of these companies had terrible fundamentals and were not appealing from a technical standpoint. What made people invest in these Internet companies was the fact that so many other people were already investing in them. The average person thought at the time that if thousands of other investors were investing in these Internet related companies then it must be a good move. This investment trend had lead many people to get trapped by the dotcom bubble that had cost them a large chunk of their portfolio.

How to avoid herding:

More often than not, jumping into a hot sector or stock because of a popular trend is not a smart move. Just because everyone is hoping on the bandwagon of a new investment, doesn’t necessarily mean it’s going to last.  The questions to ask yourself are “how does this investment contribute to my overall risk profile and asset allocation”  or “what role will this investment play in my portfolio?”

How to Plan When You Don’t Know Your Goals

Defining one’s goals isn’t easy for some people. Trying to envision what your life will look like at some point in the future can be difficult.  There are so many emotional and financial variables and so many unknowns in life that it can leave you feeling stuck or in a holding pattern until you find clarity.  We know that because it is a relatively common issue that we run into with our clients and an issue we try to help resolve for them. Retirements, illness, or the death of a family member can be very disruptive.

We help clients find clarity by trying to quantify the financial impacts of their situation and model other scenarios they are considering.

To illustrate what we do, let’s consider a typical client situation.  A couple with two college-age children have come to us looking for guidance in planning for their future.  They have very good incomes and a vacation property, but there expenses are high and they have not saved as much as they should have in the past.

Here is our process to help get this client out of their holding pattern:

  1.  We model their current financial situation and extrapolate those results out through their retirement.  Every conceivable financial variable is used to model the current situation: income expenses, accounts, assets, social security, etc.  The result is some perspective on the likelihood of maintaining the current lifestyle assuming nothing changes.  The model is summarized in a simple graphic, an example of which is below.
  2. The graphic above is presented to the client. The big circled number at the top provides a probability of success for the client to reach their financial goals.  The calculation uses Monte Carlo Simulations to imagine sequence of returns risk.  Basically, the model runs 1000 simulations to imagine how rates of returns affect a client reaching his goals.  What happens if there is a big recession early in retirement?  What happens if there is a big recession later in retirement?  What happens if the markets are flat for several years?  These are all scenarios that are modeled and considered and shows that of the 1000 simulations, 77%  result in their goals being met:
  3. In the first example above, it shows that their annual savings of $27,500 is used to successfully fund college education for two children as evident by the two green bars.  But it comes at an expense -their retirement is not fully funded as seen by the yellow bar.  This is where the conversation begins.
  4. We can begin to model changes on the fly to see how certain changes will affect their future in retirement.  In this example, the client has been wondering if they should sell their vacation property and use the savings for retirement.  We can quickly quantify the long term impact of that decision:
  5. Then we can see how that change will affect the probability of success.  We can see below that by making this one change, we have increased the probability of success from 77% to 93%.
  6. Sometimes, this gives the client enough clarity to make a decision and move on.  But that’s not always the case.  After the client has thought about making a major decision (such as selling a vacation home), they may come back saying they can not actually sell their vacation property and need to consider other options.  Below is a comparison of their current situation compared to a scenario in which they delay retirement for two more years.  The result is almost the same as if they sold the vacation property.

After this exercise, the client has two viable options to consider to get them on track for retirement.  By seeing certain scenarios modeled, it can make possible decision more real to them and hopefully more achievable.  The illustration we provide help them make better decisions.

There are lots of emotional decisions that revolve around major life decisions, like retiring, changing jobs/careers, and moving.  We believe that by addressing the financial impacts of these decisions, we can affect the emotional considerations that may be holding our clients back.  Our goal is to provide that nudge to get them moving in the right direction and to keep them from making mistakes.

If you feel like you are stuck or need help laying a clear path forward, please reach out to us:

 

A $200,000 Mistake

In early 2016, the stock market experienced a 10% market correction in a matter of a few weeks.  It resulted in a few phone calls from clients wondering if they should move to cash.  One conversation with a recent retiree really stood out for me and I wanted to share an abbreviated version of it with my readers:

Client:  At the start of the year, I had $1 million invested in the market.  But now it’s February and I’ve lost $100k. We’ve got to stop these losses.  Please sell me out of everything and put me into cash.

Me: Would you consider staying the course a while longer?  As quickly as the market can decline, it can increase just as fast.

Client: Thank you, but I still want to move to cash.

Me: How about we sell 10% of the total value of the account?  That will cover your distributions for the next two to three years.

Client:  No thank you.  I want to be in cash now.

Me: Just one last idea – how about we move 50% of the account into cash?  That will cover your distributions for 10 years.  And in ten years, you can tap into your investments for your future distributions.

Client:  Look, I rode out the 2008 and 2009 recession and I don’t want to have to do it again.  I’d rather keep it in the bank and not have to worry about the stock market.

Me:  Ok, I’ll sell everything today.

 

There is a lot to process in this conversation.  First, the client called up believing they lost money.  Between the start of the year and the day the client called, the account had declined about 10%.  The sketch below shows how he visualized the loss.

From a behavioral finance perspective, the client anchored his thinking to the high point in their portfolio.  It became his frame of reference, his point of comparison. But if we looked backward and used a different reference point the story changes.  We would see that his account balance is right where it was 12 months earlier:

The idea of anchoring to a high point is a common issue that behavioral economists study.  We, as humans, sometimes make irrational decisions.  We make decisions that we believe to be based on objective facts, but are in reality detriments in how we try to solve problems.  I tried to reframe this particular client’s thinking a few different times but was unsuccessful.

Recently, I went back and reviewed this client’s portfolio to see how he would have done if he stayed the course.  As we know, the market ended up recovering and ended the year up about 10%!

The day the client called wanting to sell out of the market ended up being the very bottom of the market “correction”. For the rest of the year, the stock market recovered from its lows in February and then began to reach new highs by the end of the year.  Unfortunately, that client stayed in cash for the rest of the year.  It has resulted in a $200,000 mistake!

That red circle in the sketch above represents a behavior gap.  This is a well documented phenomenon in which investor decisions and behaviors are dragging down their portfolio performance (Morningstar). In this case, it could have been completely avoided or at least significantly minimized.  The quick reaction to move to cash will have a lasting impact on this client, but he probably won’t notice it until his cash balance is drawn down substantially.

This serves as an example for investors to stick to their plan and avoid making sudden and drastic changes to their investment strategy… and to listen to alternative suggestions from their advisor.

Annual Returns and Intra-year Declines of the S&P500

Here is an interesting chart I came across that shows just how volatile the stock market can be during the year.  In a year where we have seen relatively little downside volatility in the market, it’s important to remember that there can be some big and sometimes scary corrections in the market.

This chart shows the calendar year returns in grey bars for the S&P 500.  But the interesting take away are the red dots that show the intro-year decline of the index.  Look at 2016, which ended the year up 10%, but was down as much as 11%.

Those “shocking” market corrections and big declines that lead investors to make bad decisions are not unusual.  They are just really scary when we are in the midst of a correction.

What Should You Do When Markets Are At All Time Highs

When markets reach heights like this, it’s a great time to evaluate your portfolio to see if you are invested correctly.  Too often, investors wait for the market to decline before doing that analysis.  That’s the worst time to reevaluate how you’re invested.

Instead, follow the old adage: Buy Low, Sell High. Perhaps, you aren’t as willing to accept a 10%-15% decline as you were 5-10 years ago.  If that’s the case we should think about taking profits of the table and moving into a more conservative lineup.

If you’re curious about how your portfolio stacks up to your risk tolerance, please complete this questionnaire.  This is an extremely valuable exercise that can compare your personal risk tolerance to your actual investments to quantify how much risk you’re willing to take and how much risk is in your portfolio.  Basically, you’re asked a series questions that will result in a risk score.  I then analyze your holdings that you maintain with us and investments held elsewhere to arrive at a portfolio risk score.  Hopefully, they match but if not we can take steps to tweak your holdings.