The financial crisis has undoubtedly changed the landscape for investing. We only thought making decisions about our investments was tedious and complex before the Great Recession. Many theories have been challenged and proven flawed. Many retirement planning strategies were broken and unable to mend. Consequently, the big question is, “Where do we go from here?” Some say gold, some say guarantees, CD’s, bonds, and there is even the suggestion of your very own savings account at your local bank.
If you notice, there is one general problem with all of these answers—they are canned. Just a moment ago we were discussing the overwhelmingly complex investment environment. Do any of these ideas seem as if they are a result of complex research for your unique situation?
Behavioral finance is a field of psychology studied since the late 1970’s that describes why we make the decisions we make when it comes to our money. And, since we are using the word psychology, I bet you can guess that most investment decisions are not made without emotions or cognitive error. Which of the following sounds like something you have thought?
- It could never happen to me
- If everyone is doing it, it must be right
- I will deal with it later, I don’t have time now
- I hate losing
- It is too good to miss out
- I never made any money there and never want to invest in that
- I lost money with that company and never want to own that again
- I have always had it
- I worked there
- That was my Dad’s
William Gross, co-founder of PIMCO, stated “Markets invariably move to undervalued and overvalued extremes because human nature falls victim to greed and/or fear.” The word “Markets” by the way is anything from stocks to bonds, real estate, energy, gold, fixed accounts, etc.
Sadly, this is the downfall of many investors. Take, for instance, tech stocks in the late 90’s. Everyone was doing it, so it must be right. Right? Too bad that these thoughts occurred when prices were peaking. We all know the rest of the story. Will this be the same story for bonds or gold? Maybe….Maybe not. But this is a great argument for not putting all your eggs in one basket.
What about General Motors? What if this was the one stock that belonged to Dad? Or, what if your very own sweat and time was in this company? That is emotion speaking and I am thinking you would not be a happy camper today if this was the one stock you owned. I like to use the analogy of an elevator. Imagine you are on the 18th floor in an elevator and it stops. You open the top of the elevator to find one cable holding you up and it starts to unwind. How do you feel? Would you feel better if you looked back up to find 30 or 40 other cables holding you up? Why, then, would you ever rely on only one investment no matter what it is? Or even placing the majority of your money in one investment?
On the flip side of the coin, no one likes losing. However, this thought often causes us to be overly conservative and run the risk of losing purchasing power. Let me ask you, do you think we are headed for higher inflation? If so, keep in mind that the average inflation rate over the past 20 years has been around 3 percent. Let’s say you live off $50,000 a year. If inflation stays the same, this will equate to over $90,000 in 20 years. If it rises…well? So even if a 3% fixed account looks good for today’s rates, there is no room for you to take income from this if you plan for the account to keep up with inflation.
The point is we are in an extremely perplexing investment environment, but you can’t not do anything. It is more critical than ever before to find a Life Planner who can help you parallel your unique situation, future and goals, family dynamics and risk tolerance to a customized investment plan. Many investors make decisions because they think they have enough information when all they really have is nothing but cognitive noise. Don’t let that be you.