Money Management - July 2006

Time to Circle the Wagons

Investor Behavior Can Make or Break You

by Brian Loy

At the beginning of this year, the single most important event in human demographics happened for the first time, and it will reoccur every 10 seconds for the next 15 years. The most affluent American generation began to reach 60 years of age.

This milestone marks the beginning of the end of the Accumulation Stage in life –a difficult transition to make – shifting gears from being a Saver to a Spender of wealth. It’s the age at which many people begin to talk seriously with their trusted wealth adviser about retirement. Age 50 is the last time you can believe in a miracle. Remember back to when Greenspan was giving his "irrational exuberance" speech. It was the 50-year-old (and younger) boomers mortgaging their homes and buying Amazon.com stock, not the 60 year olds. At 60, you try to negotiate a truce with reality, and most times you don’t really know what reality is.

One reality is longevity. Take a 62-year-old, non-smoking couple: What is the average expected age at the time of the second person’s death? The answer is a dramatic difference between perception and reality – age 92. Now mind you, this is the average... which means 50 percent will live longer. Welcome to the 30-year retirement!

So, what do you do when one of your great goals in life is to build a cash flow stream that will outlive you? (The other core planning needs include: investing for your children’s or grandchildren’s futures; managing for the risks of a disability, loss of a loved one or long term care; and building a legacy that will last for generations).

One key is to focus on what you can control – your behavior. For example, a study conducted by Dalbar examined the results of investments (the markets) and investors. Over the 19-year period from 1984 to 2002, the S&P 500 was up an average of 12.9 percent annually, but the average investor earned only 2.7 percent. That gap is huge, and largely reflects human nature (behavior).

Our human decision-making processes are badly distorted by biases and emotions. These often cause us to overestimate our level of knowledge, underestimate risk, exaggerate our ability to control events, or wait until all uncertainty disappears. They may cause us to believe we can outsmart the market by picking investments that will perform better than the market as a whole, or time the market’s ups and downs.

Focus on being a prudent investor, and avoid the Great Investor Mistakes. They include: over- (and under-) diversification; panic; euphoria; leverage; yield, not total return; speculating; and allowing taxes to drive investment decisions.

Finally, three tips for financial success:

Stay focused on your dreams and goals (e.g. security, peace of mind, freedom, control, making this world a better place). What you focus on tends to expand.

Have a written wealth plan, and update it as needed (things change – life is curly). People who have plans know where they're going.

Dedicate yourself to asset allocation. While I don’t know how long the rebuilding of Iraq will take, or its cost, I do know that my wife’s and my joint life expectancy exceeds 45 years. Hence, I’ll focus over 90 percent of my time towards asset allocation, with the remainder of the time devoted to investment selection and timing.

And, if you feel uncomfortable circling the wagons alone, get together with your trusted wealth adviser.

Brian Loy CFA, CFP
Brian Loy, CFA, CFP, is president of Sage Financial Advisors, a wealth management firm headquartered in Reno.