I used to review my investment portfolio at least once or
twice a week and when it fell, I became concerned about losing money, and when
it gained, I was happy about making money. A conversation with my advisor
helped me understand that I was investing for the long term, not the short
term, and that the market today is volatile.
I am not alone in my obsession
with my investments. One of the greatest challenges retirement planners face is
relieving the anxiety their retired clients experience during market drops and
other events that may affect their portfolios and potentially their income.
Because I understand that markets can be volatile, and I am
investing for the longer term, I do not react with panic when the market goes
down. Market volatility is the primary catalyst behind many bad financial
behaviors retired investors engage in under stress, such as buying high and
selling low, or divesting a portion of their equities to invest in stocks.
Understanding behavioral and cognitive psychological theory and
conventional economics, we can use behavioral finance strategies to identify
triggers that cause individuals to make certain—usually bad—financial
decisions, and recognize past financial mistakes in order to avoid repeating
them and putting their retirement income at risk. Here are some behavioral finance
behaviors that you should be aware of as you think about your investments
·
People tend to view the possibility of recouping a
loss as more important than the possibility of greater gain.
·
Investors tend to place too much worth on judgments
derived from small samples of data or from single sources. For instance,
investors are known to attribute skill rather than luck to an analyst that
picks a winning stock
·
We have the tendency to attach or "anchor" our
thoughts to a reference point - even though it may have no logical relevance to
the decision at hand. For example, some investors invest in the stocks of
companies that have fallen considerably in a very short amount of time. In this
case, the investor is anchoring on a recent "high" that the stock has
achieved and consequently believes that the drop in price provides an
opportunity to buy the stock at a discount
·
We use mental accounting. Mental accounting refers to
the tendency for people to separate our money into separate accounts based on a
variety of subjective criteria, like the source of the money and intent for
each account. According to the theory, individuals assign different functions
to each asset group, which has an often irrational and detrimental effect on
their consumption decisions and other behaviors.
·
Although many people use mental accounting, they may
not realize how illogical this line of thinking really is. For example, people
often have a special "money jar" or fund set aside for a vacation or
a new home, while still carrying substantial credit card debt
·
The reason we do this lies with the personal value
that people place on particular assets. For instance, people may feel that
money saved for a new house or their children's college fund is too
"important" to relinquish. As a result, this "important" account
may not be touched at all, even if doing so would provide added financial
benefit.
As we age, we should be seeking less risking investments, so
that we can generate income, because having high risk investments, may be
destructive in the long term
I know that I am uneasy when my investments earn low or show no
gains in a flat economy, which can activate some of my behavioral finance
actions (see above) that may also lead to bad financial behaviors. My advisor
suggested to me that I could minimize losses by merely staying the course and
resisting the compulsion to take on risk.
I assume that all of us who are retired experience heightened
anxiety over their financial security at one time or another. A recent American
College survey (pdf file) showed that more than 60 percent of us are
concerned with market volatility significantly impacting their retirement
income stream.
In a discussion with another investment consultant, I was
told that the biggest problem faced by retired people is that many of us often
over-estimate how far into retirement their savings will last, and don’t plan
for unexpected expenses such medical care that accompany retirement. Minimizing
risk and establishing a financial plan that meets one’s retirement goals
without draining their savings prematurely requires planning and flexibility,
as this is not always an easy transition for retirees
It is important to understand that until we begin withdrawing
money from our savings, there is no impact on our portfolio. However, selling
stocks right after a significant market downturn can lock in lower returns,
which can negatively impact the longevity of a retirement portfolio.
If flexibility with retirement income is not possible, you
can consider securing enough guaranteed income sources to cover your basic
retirement needs—a strategy often referred to as flooring, which is usually
accomplished through a combination of investments and insurance products such
as bonds and annuities that can help provide a predictable amount of income
each month in retirement to meet expenses.
Coordinating annuity or bond purchases with other consistent
income sources, such as pensions, Social Security, or rental income can help
provide reassurance during volatile markets, and allow retirees to focus on
enjoying their golden years instead of worrying about meeting expenses.
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