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How to Plan When You Don’t Know Your Goals

By Posted on In Finding Confidence, Investment Behavior, Investment Strategies, Personal Development, Retirement, Saving

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

By Posted on In Finding Confidence, Investment Behavior, Retirement

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

By Posted on In Finding Confidence, Investment Strategies

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

By Posted on In Finding Confidence

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.

Fake News and Your Investments

By Posted on In Finding Confidence

For readers of this blog, you know how I feel about financial journalism these days. The talking heads and the supposed experts we see on TV and read about in the news are doing a great job making people nervous and afraid to invest. It’s clearly having a negative impact on decisions most investors make. Investors tend to be nervous when the markets become volatile but when the media reconfirms their fears or exaggerate their concerns, the investor is more likely to follow the heard.

Lately, the whole concept of Fake News has come into focus as people call out poor reporting. While most of the backlash is focused on political journalism, I believe that financial journalism is even more prone to reporting of half-truths and spreading of misinformation. Journalists know how to stoke fear and anxiety for an investor with clever headlines and drawing comparisons or conclusions in ways that are factually and logically incorrect.

I hope the pressure continues and that the media can reform itself and realize they can help people stay the course in reaching their financial goals. Right now, the majority of the content from CNBC (and most media) is good for entertainment purposes but rarely would I consider it reliable or educational in nature.

Critiquing a Financial Plan

By Posted on In Finding Confidence, Investment Behavior, Personal Development, Retirement, Rule of Thumb, Saving

The following article examines five young people and their financial plan (more like their lack of planning).  They are then offered some preliminary advice about how to improve their situation.  Unfortunately, in every case I found the advice to be overly simplified.  Here’s the article

And here are some overarching strategies that apply to all the case studies:

1)      Emergency fund.  Start here first and make it a priority to build an emergency fund that can cover non-discretionary expenses for 3-6 months.

2)      Save more.  If you can’t save more now, earmark any future raise toward saving.  When asked about a rule of thumb for how much to save, I’ll often respond with “Save as much as you can”.  Young people and millennials are unlikely to have pensions and with the questionable future of Social Security, the burden to save is placed on their shoulders much more than previous generations.

3)      Automate.  Make sure any savings are set to occur automatically.  The mental anguish of writing a check every month or year to a retirement account can be surprisingly difficult.  Many times it is our own biases that create obstacles to reaching our own goal and simple processes like automating our savings can have a huge impact.

4)      Disability.  Life insurance is commonly discussed when a couple has children.  But disability insurance is rarely brought up.  What’s odd is that people are more likely to file a claim for disability insurance than life insurance.  And it doesn’t apply just to physical injuries, either.  We’ve had several clients and prospects tell us about their long term disability that affects their ability to do a desk job as a result of a bad car crash.