"Everyone has a plan until they get punched in the mouth" - Mike TysonSubmitted by InFocus Financial Advisors, Inc. on April 27th, 2017
Since 1950, there have been 58 different 10-year periods (i.e., the 10-years from 1950-59, 1951-60, 1952-61 . . . , 2007-2016). The S&P 500 has produced a positive total return result in 56 of the 58 decade long periods, i.e., 97% of the time. (via BTN Research).
Like most things in life, everything is great until it’s not. The same can be said of investing in the stock market, especially for a retiree or near retiree. While we know that the buy and hold for a long-term investor is a tried and true method of accumulating wealth, statistics such as the one above for someone who is distributing their assets can be quite misleading. Taken out of context, it can lead a retiree to take on too much risk, withdraw too much from their portfolio, or even become far too conservative in anticipation of the sky falling. What we will explore in this article are 3 behavioral biases that can unduly influence your investment decisions and expose your retirement plan to significant risk.
Recency. If you have seen any film depicting Wall Street, you know you should be buying low and selling high. If only it were as easy as it looks. If you could have moved what you had left of your portfolio to 100% stock in March of 2009 knowing what you know now, would you have done it? Hands up. Of course, 305% over 8 years isn’t too bad. The problem is that 8 years removed from the financial crisis, the pain we felt of having our portfolios being cut in half has faded to black. Recency is what investors are feeling. The farther away something is, the less significant it feels. On the heels of an 8 year bull run we place much more significance on what have you done for me lately. At the helm of your own portfolio, and down 40%, at what point was it safe to re-enter the market if? 1 year? 3 years? The same market risks are still here today as in 2008. I am not here to argue about Dodd-Frank or the quality of our Financial system post-crisis (maybe another time), but there is nothing that says the market can’t dip 5% tomorrow or 20% next month. Having to fight the volume of rhetoric coming out of your TV from business networks about the next exotic way to buy stock in the 8th year of a bull market is a war you can win. Having a risk-managed investment and withdrawal strategy for your retirement years is of the utmost importance. Knowing where your next mortgage payment is coming from, or the fact that you can still take that trip with your spouse in the midst of the next financial crisis is the most important part of your portfolio. Succumbing to Recency is a doing quite the opposite of the old Wall Street adage and ignoring the painful lessons the market has taught us over the years.
Gamblers Fallacy. Now I understand that the above statements and sentiment may have come off a little Bearish. Every time I hear the current Bull market referred to as “The 3rd longest in history”, “Over-run”, “Long in tooth” I cringe. It's not that some of the monikers aren't true, but the perception is that we are on the cusp of a correction. Bull markets don’t die of old age. Nor do I have any idea in which year this one might die. You may have heard this one before; The Gamblers Fallacy. Picture yourself sitting at a Roulette wheel and watching it come up black 50 times in a row. Where are you placing bet 51? The odds haven’t changed. It may come up black 50 more times and you may run out of money waiting on red. Bets on what the market may do tomorrow, a month from now or even next quarter are as good as sitting at a black-jack table. You may have noticed an up-tick in commercials for Gold and Silver backed IRA’s lately talking about the US debt and what trouble the economy is headed for over the next 12 months. What they forget to mention is if you owned gold the last 5 years, you would be down to about 55% of your original investment. Short-term predictions of robust growth or doom and gloom are as good as fairy dust. New legislation, monetary and fiscal stimulus all take months if not years to work their way through the economy. Making decisions on where the market and economy might be in 36 months would be more prudent. As a retiree, an even better idea might be setting aside some funds for withdrawals that will allow you to not have to sell from investments that have significant losses to provide needed income in a downturn. Investing strategies shouldn't remotely resemble the odds when you walk into a casino. Know what assumptions your strategy is based on.
Loss Aversion. Speaking of downturns, one of the most interesting pieces of behavioral investing comes with Loss Aversion. Investors hate to take losses. They hate to take losses so much it has even been quantified. In 1979, a study by Kahneman and Tversky found that a loss has about 2.5 times the impact of a gain of the same magnitude. Further studies have shown that for a retiree who is utilizing their portfolio for income, the losses are felt 4 times the impact of a gain of the same magnitude. Circling back to the beginning of this article, I know that my clients being down 20% will feel 4 times worse than me giving them a report that we are up 20%. That has to be accounted for. The tolerance for pain is different for everyone. The S&P 500 averages a -14% intra-year decline yet finishes in the green 97% of the time. Most investors are probably accustomed to this and are rewarded for it over the long-term of their working career. How about when you need that portfolio to write you a monthly check? How do you feel at -20%? Is your strategy still intact at -40% or are you selling everything? I think Mike Tyson said it best; “Everybody has a plan until they get punched in the mouth.”
Even the most detailed financial plan cannot model how an investor will behave through the next financial crisis. Partnering with an Advisor who has prepared you for these moments are worth their weight in gold. In the 5 years leading up to Retirement, it is important to start thinking about your retirement strategy. Here at InFocus Financial Advisors, we take the time and effort to understand the mechanics of portfolio construction and human behavior. While we are yet to find the silver bullet to a retirement strategy, we believe a full understanding of the way we behave in different market conditions is of the utmost importance to helping you reach your goals.
The views are those of Eric Johnston and should not be construed as specific investment advice. All information is believed to be from reliable information; however we make no representation as to its completeness or accuracy. Investors cannot directly invest indices; past performance does not guarantee future results.
Securities and advisory services offered through Cetera Advisors LLC, member FINRA/SIPC. Cetera is under separate ownership from any other named entity.