Since I began my independent advisory firm, I have concentrated on treating each client who has come through my doors a part of my family. If I am to help someone properly, it is important that I truly understand their entire financial situation thoroughly. I feel strongly that if I come to know the entire situation clearly, I can provide a solution for each that coincides with his/her financial goals. Oftentimes, advisors and brokers do not do their homework. They do not understand their clients enough. As a result, consumers are sold a product or a mutual fund or a “managed” portfolio and are left wondering at the end, “What happened? Does this solve my problem?”
A huge problem exists in the financial industry. Financial professionals overlook key points that need addressing. In essence, they go for a sale instead of providing help. This occurs for various reasons. Some advisors must sell the products their company promotes. Others sell only risk-type investments. Furthermore, far too many advisors do not understand the difference between risk and safety.
In a previous blog post, I explained the Rule of 100 and the Pyramid of Investing. The basic idea is that during retirement, you really need to alter your path away from the traditional way of investing. While it is all right to have a good portion of your money on Wall Street and “at risk” during your younger years, a good rule of thumb is to begin tapering that amount as you grow older and inch closer to retirement. The reasoning behind this concept is that you now have much less time to recoup any kind of market loss or downturn, especially if you will need your money to supplement your income during your retirement years.
The pyramid of investing to the right describes the Rule of 100. On the bottom of the pyramid, you will see listed only the four (4) types of accounts that are considered safe: Fixed Annuities, CD’s, Government Bonds and Insured Deposits. The rule of thumb is that you should use your current age to determine how much of your money should be invested at this base level. Unfortunately, if you talk to a broker or a money manager about safety, they will not talk to you about these four (4) accounts. The realm of possibility for them lies in the second level of the pyramid, in what Wall Street calls “safe.” These are holdings like municipal bonds, high-grade corporate bonds, Ginnie Maes, preferred stocks, etc. These investments may be conservative but are still subject to the ups and downs of the stock market. Most of the time, when a prospective client says the word safe to a broker or a money manager, it is like playing a word association game! You say “safe”; they hear “conservative.” You see, these accounts are at the low end of the risk spectrum.
In this instance, the client is already being misled, and the relationship has begun on a bad foot. A broker/money manager may take it a step further and offer you the “conservative allocation.” You can also refer to this as the “pie.” In this example, he/she will take different allocations of stocks and/or mutual funds and “diversify you in a portfolio.” Their idea of conservative allocations is that when one stock begins to fall, another position begins to rise to balance out the loss. What happens when the entire stock market falls? Where does the offset come in?
In retirement, an investor is better off dealing with “True Diversification” as opposed to “Asset Allocation.” Rather than dividing assets within a pie and all “risk-type” positions, the investor should preserve a portion of the money in something that is safe and cannot lose principle if the rules are followed. Again, as financial advisors, we’re talking about government bonds, fixed annuities, CD’s, or insured deposits. I know what you are thinking! “But, Bill, I won’t make anything in those investment vehicles!” But guess what? You won’t lose anything, either! With the right guide, you can earn 5-8% safely!
Why would you put your money at risk in the market if you could achieve a strong return in something that can’t lose money? Ahh! It is said that things that sound too good to be true usually are, right? The only thing that is too good to be true is the lie that Wall Street tells investors about averaging 10% a year on their money. Most people pass on the safe vehicles because they want to obtain a better rate of return. According to a recent DALBAR Study, the average investor didn’t realize that if he/she would have locked himself/herself in to a CD paying 5% ten (10) years ago, it would have outperformed the stock market today. On top of that, you would have never had to check your account statement or the closing prices to determine if you lost or made money! It’s time to wake up! According to Bill Gross of Pimco, one of the world’s largest publically traded funds today, “Investors should only expect investment returns of 4-5% - ‘half-sized returns’ – in all sorts of assets for the foreseeable future.”
SO WHY DO INVESTORS FAIL?
The decisions that weigh heavily on the mind of average investors succumb to what business school professors call “behavioral economics.” According to Dr. Dan Ariely, the behavioral economics professor at Duke University, as consumers, we fall victim to certain behavior that causes us to fail in retirement. I go over some of these terms in my educational workshop, but I want to cover a few examples here. First, let’s talk about sunk cost fallacy. This behavioral nightmare will cause investors to hold on to their investment while it loses money. Many people that I see on a week-to-week basis have been holding on to their investments for extended periods of time. During that time, they have not made any money whatsoever! Even worse yet, they will hold it until it is worth nothing!
The following is an example:
Imagine an investor who owns a large amount of stock in the company he retired from 5 years ago. He has owned this stock for a long time and it makes up a large portion of his retirement portfolio. Over the last 10 years, this stock has lost value and his $1,000,000 of Stock A is now only worth $500,000. When approached about a different strategy and taking some of that stock off the table, his response is, “Well, I think I need to wait until the market comes back before I sell. I will sell it when it gets back to the price I paid for it. Besides, I have had this stock since I started working. My dad owned it; my grandfather owned it. I have had it this long; I just need to ride it out now.”
In this example, the investor is sunk in his cost. No matter what the stock does, he will ride it down until it is worth nothing before he would make a move on it! Timing the market is not an option, and he already said he wouldn’t consider selling until it was at least worth what he paid for it. Take it one step further. Let’s say the market rebounded. If his $500,000 made it all the way back to $1,000,000, do you think he would have the discipline to sell? Better yet, what if it never comes back?
Suze Orman said, “I know this subject [money] is serious stuff. Your future is riding on it. But taking control of your financial life doesn’t need to be a solitary and scary process. Fear comes from not knowing what to do or how to do it. And when we are fearful, we do nothing….”
Most people waiver when it comes to choosing a financial professional to help them plan their retirement. The myriads of choice available to them are abundant. Suze Orman says you should not be afraid to seek out help. The fear we experience stems from the lack of knowledge we have in any endeavor. When choosing an advisor, be sure he/she understands the difference between safety and risk. It could ultimately determine if you will travel down the financial path you want to go!
-Your Retirement Guru
Bill Smith
Bill Smith is a RFC and the president and founder of Great Lakes Retirement Group, a Registered Investment Advisory firm located in Sandusky, OH, and Sheffield Village, OH. For further educational information or to attend one of Bill’s free educational classes, please email ContactUs@GreatLakesRetirement.com with the subject line “Blog” to receive more information.
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