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Psychology of Money

Category: Articles Published: Thursday, 26 May 2011 Written by Administrator

Money, Myths, and Morasses

Curing Our Monetary Malaise
By Steven Wightman, CFP

Investors are mesmerized into markets based on misunderstanding of information and pure myths. During the past 10 years millions of investors have lost more than 50% of their savings – largely in retirement funds, according to July 14th article in both the NY Times and the Boston Globe. Why? Because they have been sold a false bill of goods by so-called money experts who were nowhere to be found when markets and the wisdom of their advice collapsed.

Major myths:

  1. My investments will bounce back! People believe that no matter how unwise or bad an investment they made, whether it is or a technology stock or portfolio that somehow the 50%+ decline will reverse itself and then climb as if time will go in backward to 1999. Here investors often show little understanding or concern about diversification or life-stage investing, never mind risks. Most investors began with an inappropriate asset allocation and ended with something worse because the severe impact of the 2007-8 market crash has mangled their asset allocation into a wreckage – now badly in need of a reworking. If stock equity is still the growth locomotive of investing, how will investors who sold stocks on shivers meet critical financial goals like retirement if they don’t replace half of the equity values they lost? Why do so many people continue to make knee-jerk asset allocation adjustments?
  2. Sell on bad news, buy on good news. This is a formula for buying high and selling low. Media moves markets. People buy high and sell low based upon what’s in the news that day. When Tyco International’s CEO Dennis Koslowski was indicted for state tax sales evasion, millions of shares were sold off following the news. No one paid much attention to the fact that this conglomerate is in rock-solid financial condition with enormous free cash flows. Every time the media flagged a company or their employees for questionable practices, some truly justified investors ran for the exits and stock values collapsed – hurting everyone.
  3. Equity premium: That percentage amount that stocks historically have outperformed bonds is still widely touted by media and large brokerage firms even though it has likely evaporated due to the declining stock dividend yields since the 1970’s. Where stocks once paid a 5% dividend, today the average is about 1.2%. This shrinkage makes stocks less attractive and less valuable to investors. With less intrinsic value, they are less likely to beat bonds by 3-5% in the future. Hence, their higher volatility over bonds may no longer be worth the risk past investors were willing to take; yet investors keep buying because they expect stocks to deliver 10-13% returns. Brokerages are only too happy to encourage this myth.
  4. Money managers make sure you understand fees, costs, and alliances with firms and individuals they receive economic benefits from before you invest. Their requirement is to disclose, not to explain. There’s a vast difference between handing you a 60 page prospectus or sitting down with you to explain bone by bone the structure and costs of proposed investments. By far, most in the financial services industry are not fiduciaries. They don’t have to represent your best interests 24/7. Only those who bear the CFP mark and NAPFA members can be relied on to meet this standard. The result is that you are probably either not getting any information or not the best information. Hence, investors often do not understand how a new investment impacts risk, return, and taxes in asset allocations. Consequently, their portfolios underperform expected total returns due to trading, fees, expenses, and taxes because they didn’t read in the fine print of a prospectus. These costs may exceed the rate of return for a mutual fund or annuity for a given year and create substantial drag on investment growth. (See my quote in Kiplinger’s June issue on Exchange Traded Funds). In poor performing times, as in the past 10 years, such investments aggravate losses. A portfolio with a 10% loss and 5% fees and expenses over 5 years can eat a savings plan.
  1. Affluenza: The addiction to having things based upon a false sense of need and the belief that if we earn more and spend more we’ll be rich and happy. It is interesting to note that the more people earn, no matter how much that is, the more they spend. You can’t spend your way to wealth or happiness. It often sets the stage for just the opposite. The more we spend the more complicated our lives become. More complicated lives lead to more stressful situations which in turn rob us of our happiness, vigor, and vitality. Lastly, because we are spending now and not saving, we are sabotaging our own future.
  1.  We’re saving enough and we’ll be fine for retirement. Perhaps the greatest myth of all. Although the vast majority believes they are on track, studies indicate that less than 5% are preparing adequately for retirement. The average retiree has less than $35,000 saved on the first day of retirement. Interestingly, the 5% who are on track plan for it. Those who think they are okay have no written plan and when questioned, have no idea of how much they need to retire or how much (it follows) they need to save to reach that milestone. A common finding in the book The Millionaire Next Door is people who consume the most, save the least, pay the highest income taxes, and confuse high income with wealth building. They are not the same. When income stops due to death, disability, joblessness, or retirement, high-rollers often find themselves in poverty lines, living off Ebay, or parental outpatient care, aka, parent-to-child welfare.
  2. We don’t need professional advice; we’ll do well without it! Millions of Americans march into poverty griping this belief and their empty retirement plans. The odds are stacked way against those who go it alone - the vast majority fail. For example, the top 3.5% of the wealthiest Americans own nearly half of the wealth in America. They have two things in common that all the rest do not. They plan their futures at least 8 hours per month AND they prize professional advice. They understand that you can’t will away all risks, but you can manage them. Getting the best advice helps them avoid big mistakes and make better choices. It’s their way of insuring a secure financial future. They believe that you get what you pay for. The results speak for themselves. A disproportionately high percentage of this 3.5% flock to NAPFA advisors – perhaps because they understand that these financial advisors meet the World’s highest standards for offering personal financial advice. The role of a good financial advisor is to treat money malaise. The untreated are likely to continue making ill thought choices.
  1. We’re already getting high-quality advice. Okay, then it follows that you should be able to readily cite the training, credentials, and experience of your advisor. Take a moment now and answer these golden questions. How many times in the past 10 years have you been given advice by your advisor that has resulted in a substantial increase in your net worth? How many times has your advisor provided you with advice that gives you a sense of peace of mind, enhanced your financial security?

If investors could learn a valuable lesson from a meltdown it is not to “pennywise and pound-foolish” as the wise Senator Edmund Muskie of Maine often said. The majority of people continue to lose tens of thousands of dollars each and every year, exposing their families and estates to enormous risks. Risk wise, they are not unlike JFK, Jr. flying in the dark with his family on the fateful Martha’s Vineyard trip - but many won’t pay a fraction of what they’re losing in markets for the unbiased advice of a Certified Financial Planner professional. 

Myths make morasses and more asses make myths. Money myths are like religious beliefs: People hold them dearly and reticently closely to their chests – even when their finances are in a death spiral. These common myths are our gossamer wings on which we ride, superficially blissful of the growing storm. Instead of carrying us to our desired sunny levels of a secure retirement, they shatter in downdrafts, leaving us and our futures in a free fall. Take a lesson from Shakespeare’s legacy; don’t let your money control you, but take control of your money – and your life. That’s the cure for monetary malaise.

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