Month: May 2014

Shifting the mental and financial gears for retirement

Retirement. It’s that glimmering prize on the horizon that so many of us dream of, work hard for and save.

You would think after literally years upon years of diligent planning and savings, it would be easy for most folks to kick back and enjoy the newfound freedom and realities of retirement. But the truth is, it’s not always that easy.

Instead many people are troubled with questions, including:

• Will I outlive my money?

• When should I start taking Social Security?

• And, in particular, do I dare beginning drawing down the money I worked so hard to save?

For many, the notion of dipping into that carefully amassed financial reserve is tantamount to a sin. I’m not sure if folks have a hard time accepting the fact they’ve actually reached retirement age or if they’re simply hesitant to cut the first slice off the beautiful pile of money they’ve built, but either way a serious mental shift is in order.

One of the most effective ways I’ve found to help people transition from the “building my retirement savings” phase of life to the “living off my retirement savings” phase is to create a plan.

To begin with you need to determine how much money you actually have in terms of savings and other investments; what income you might still have coming in from interest, investments, social security and other sources; and what is the expected growth rate of your savings and investments.

Next you need to evaluate your expenses and determine how much money you need to live on a monthly basis.

With those numbers in hand, you can figure out a practical balance for tapping into your retirement savings. Depending upon how you like to manage your money, you can draw down as needed or you can set up monthly or quarterly transfers to your checking account to live off of much like those once-familiar paychecks.

Like any financial planning, your retirement living plan needs to be tracked and monitored regularly to take advantage of both up- and downturns in the market and to adjust for any changes in your personal situation and other expenses (e.g. a dream vacation or a fishing boat).

While successful retirement living takes a bit of planning and effort, it’s not nearly as difficult as saving for retirement. Plus, you’ve got a whole lot more time to do it.

Have you ever wondered why it is that people (including myself) tend to accumulate “stuff” in their basements and attics? You know the stuff I mean – old furniture, clothes, boxes full of whatever from when you moved 15 years ago that you were sure you’d need again someday. How about some losing investments? Why don’t we just get rid of it? The answer lies in a well-researched psychological trap called “loss aversion.”

Studies have shown that the pain of a loss is almost twice as strong as the reward felt from a gain. The emotion of loss is a very powerful negative emotion and causes us to put too high a value on things that really aren’t worth that much. Hence, we’ve got stuff.

The same aversion to loss occurs in a number of forms in the investment world.

One is the tendency to hang on to losing investments. It’s not uncommon for me to see investors with holdings that are down 60, 70, 80 and even 90% from where they were when purchased. By ignoring the fact that the investment was a bad one and not selling, the pain of loss is avoided while the realities of loss are mounting.

Loss aversion also leads investors to focus too much on negative results and not take a holistic view of an entire portfolio. For example, if in a portfolio of twenty stocks all but a few are up in value but those few that aren’t are in the red, loss aversion leads most investors to focus almost exclusively on the loss and make overly-conservative decisions going forward. It’s a vicious cycle in which the risk of loss leads to the risk of being overly cautious; both of which can be financially detrimental.

So how do you avoid falling into the loss aversion trap? It’s not easy but start with the simple mantra of “letting your winners run, and be quick to sell your losers.”

Because it’s impossible to invest without having the occasional losing pick (or two or seven), I recommend utilizing trailing stops on your investments. Trailing stops are simply pre-determined percentages at which you sell your investment. By setting trailing stops when you buy an investment and hopes are high rather than when you’re feeling the potential pain of loss, you can be more rational and less emotional in the setting. The exact percentage you set in not as important as following through with the sale when the stop point is hit. Set it and follow it. No matter what your heart says.

In much the same way you might seize this time of year as a time to get your house in order, I encourage you to get your finances in order, too. Either on your own or with your financial advisor, review your investment “stuff.” Take a good hard look at what you’ve got and get rid of what’s not working. Try to keep emotions out of it and focus on the real usefulness of what you have. Is it contributing to your financial goals? If not, get rid of it. And for the stuff you do decide to keep, set trailing stops. This small effort will make it easier to part with that which is not working in the future and maximize the potential of what is.