Wednesday, January 4, 2017

Do you worry about your investments?

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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