Year: 2014

Planning so you enjoy the wins, and prepare for the losses

Last year was a great year for U.S. stock markets, with all the major indexes up over 25 percent for the year. While this year has not been quite as strong, the major averages are all in positive territory and new all-time highs are being made on a regular basis. That leaves a lot of investors feeling pretty confident.

It’s in periods like this that we hear a lot of people taking a buy-and-hold approach; the idea being you simply ride the market up, ride it down during bad times, and hope that when it’s time for you to start using your investments it’s not down too much. This is not our preferred strategy – in fact, we fail to see much strategy in the approach at all.

Here’s why:

It’s been six years since the S&P 500 has suffered a down year. History shows us that on average the US stock markets go down on a calendar year basis every five or six years. Guess what folks. We’re there. Does that mean we think the bottom has to fall out or that the market is going to crash next week? The answer is “no” on both accounts.

What we do think is that we have enjoyed fantastic gains since the market lows in early 2009 and that a bit of expectation tempering is in order. That includes re-visiting what steps you’re going to be taken when the market does drop. And, yes, when. It’s not a matter of “if” the market will drop but rather “when.” You want your defensive strategy in place before the things start to turn. Having a pre-set strategy helps ensure the actions you take are truly precautionary rather than reactionary.

One of the most common investment defenses is the use of stop-loss orders. A stop-loss order establishes a point at which you will sell off a falling investment. However, if you actively use stop-loss orders, you want to make sure your stop-loss points are where they should be, especially for investments that have been making great gains. As stock prices run up, your stops should be adjusted so any significant gains made aren’t lost in a quick tumble. Often investors will set what are referred to as trailing stops. Set at a defined percentage away from the current market price of an investment, trailing stops essentially make automatic stop-loss adjustments for you.

Another defensive approach is to sort your holdings by relative performance and then sell your laggards and let your winners continue to run. In other words, if it ain’t broke don’t fix it but if it is broke, get rid of it.

If you’re looking to get into the market rather than exit, a good defensive is strategy is what’s called dollar cost averaging (DCA). This refers to the practice of buying a fixed dollar amount of a particular investment on a regular schedule. For the sake of example, let’s say $40,000, spread out in $10,000 increments per month over the next four months. If the price during your first purchase month is $10, then $9 in the second, $8 in the third, and $7 in the fourth, you actually end up purchasing more shares with the same $40,000 than you would had you bought it all in the first month. Plus, the average cost per share across the four months would be lower than it was in the first month ($8.50 v. $10). In this way, DCA lessens the risk of jumping in with both feet a market high.

In some ways, investing is a lot like a team sport that has both an offensive and defensive squad. While it’s great to have offensive control, it would be foolish to begin a game without a ready defense. You can never really be sure when the tables or momentum are going to turn. But unlike a friendly flag football game where a loss might leave you limping home with a bruised ankle and ego, the results of failing to protect your investments with a strong defensive strategy can be much more significant and longer lasting.

My advice is to enjoy the wins but to prepare for the losses. While losing at anything will never be fun, with adequate preparation and planning you’ll not only survive the losses but will be in a better position to get back in the game than those who failed to prepare.

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.

Are your decisions about your 401k contributions today leading you to financial security; or living with your kids in retirement?

As  financial advisers, we consider it our personal mission to help our clients reach their financial goals, and we take it quite seriously. Given that the No. 1 goal for pre-retirees is to be financially prepared for retirement, some recent data from PLANSPONSOR DC (defined contribution) gave us pause.

The survey found that of 5,000 polled retirement sponsors, only 12 percent of them were confident that their organizations’ employees will achieve their retirement income goals by age 65. A startling (at least to me) 20.4 percent were not confident at all.

While the financial press has featured a lot of news lately on the importance of fee transparency and the need for clearer disclosures, the simple root of the problem isn’t with the plans. It’s with the participants. Or, rather, their lack of willingness to participate at the necessary level.

The current average plan participation rate is around 6 percent. If your goal is to save enough money to replace more than half of your wages in retirement, your 401k contributions rate needs to be at least 10 percent. And that’s the minimum rate if you are starting in your 20s. Ideally, you increase your contribution annually so that by the time you reach your 50s you’re working toward or hitting the IRS maximum ($23,000).

However, through our conversations with 401K participants, we know that this ideal isn’t reality for most folks. We hear a lot of “next month” and “next year” in people’s financial planning, but all too often, those “next” whatevers never come. Instead, bills, babies, education and other things take priority. And we get that. It’s hard to think about saving for 20 or 50 years down the road when you’re just looking at covering the bills next month.

But, as we encourage all of our clients, we encourage you to give careful consideration to how your actions now will determine your options later.

If you’re not one of the lucky few who can count on a big inheritance in the future, your options fall into one of two camps. The first is shaped by your decision not to contribute to your 401K at the necessary rate (and potentially pass up free matching money from your employer). It has the potential to look like this: live with your kids or live on charity. Not so pretty.

Option two, which is shaped by your decision today to control your future financial destiny, is more likely to look like this: a secure retirement with options for the manner and place in which you live. A much nicer potential reality.

Granted, not everyone can hit the IRS maximum contribution level but everyone can make an effort to give a little more. Even small increases taken directly from your check and, again, potentially matched by your employer (read: FREE money), is the best way to make your idea of a secure and comfortable retirement possible.

The importance of a sell discipline for retirement investment…

Whipsawed and Loving It

I went to the online dictionary Investopedia to look up the definition for “Whipsaw” and this is the definition:  A condition where a security’s price heads in one direction, but then is followed quickly by a movement in the opposite direction. The origin of the term is derived from the push and pull action used by lumberjacks to cut wood with a type of saw with the same name.  Look at the picture to the right, saw #2 is the best picture of a saw that can actual deliver a whip.  Visualize 2 people holding the

saw, one on one handle, and one on the other handle.  The benefit of using this saw is that one person at a time pulls on the saw and then lets their arms go slack so that the other person can pull the saw back.  This increases the speed to cut a log and reduces the effort since 2 people do the sawing. In the investment world, whipsawed has come to mean typically that you sell a security as the price declines and then in a relatively short time the price reverses its negative path and goes back up above the price that you sold it at.  Naturally if that happens, you feel like you have sold at the wrong time and now are reluctant to buy back the security at a higher price than you sold it at.

Risk management is defined as adopting a sell side discipline that protects your money as the market goes down.  Sell discipline means that you have created a predetermined exit point that you execute absolutely as the market goes down.  The exit point can be based a variety of measurements.  We use relative strength as the measure.  So for example if bonds exceed on a relative strength basis the relative strength of stocks it would meet one of exit points that we use on some of the portfolio models.  Predetermined exit point means a percentage reduction in equity holding and a percentage increase in the bond holdings.  Increasing bond holdings, most of the time, means decreasing risk in the portfolio.  (Naturally depends on what type of bonds and the interest rate environment.)  All of the above is good news if the overall stock market is going down.  The bad news is that periodically you get “whipsawed”.  Meaning your exit point was met and you take the predetermined action that I just mentioned.  And then the market goes back up.  Your thought could be, “I sold too soon.”  Or your thought could be, “Wow, the sell discipline really works…THINK WHAT WOULD HAVE HAPPENED IF THE MARKET CONTINUED TO GO DOWN!”

The importance of sell side discipline, meaning the commitment to take action without hesitation, can save valuable portfolio dollars in a negative market.  Now, what is the antidote for the negative side of “whipsawing”?  The answer is you wait until your predetermined buy point and take action absolutely.  Does this mean you could wind up increasing the portfolio’s percentage in stocks at higher price?  Yes!  Establishing sell points and buy points must be done with some margin between the points so that the buys and sells do not happen quickly and repeatedly.  My experience has been that many people exit the market during negative trends but fail to get back in the market when the trend is reversed.  Discipline, Discipline, Discipline!  It is the price to be paid for “sleep through the night” money management comfort.

If you are a 401k participant, this article is worth a read.

This article by Catherine Golladay, from Schwab, was published on her blog featured on the Huffington Post website. 

Click Here:  “401k Resolutions for 2014”