Don’t Let Fear of the Unknown throw Shade on your Retirement

Fear is the mother of all emotions

Call it plain old fear or fear of the unknown, it does not matter.

Fear stops us in our tracks. Fear often shows up when it shouldn't.

Like, right before you're about to retire! 

We all have this idea that when we retire everything will be so much better, so much easier, but the reality is often different. 

Instead of stressing about work, the daily commute, and evading your "way-too-young" boss all you now have to look forward to are leisurely strolls on a sunny beach, relaxing evenings with fellow retirees, and fun-filled activities throughout the day. Am I right?

Retirement is supposed to be stress-free, right?

You would think so, but in reality maybe all you have done is swap one set of fears for another.  

Fear can become overwhelming and cripple people the same way that a physical disability can. Fear is debilitating. Unchecked it can seriously harm the quality of our existence, and cause damage to our physical and mental souls.

robin Sharma

-motivational coach

"The fears we don't face become our limits"

Transitions can be scary

Anytime we face a major transition in life we have to deal with the inevitable voice in our head that warns us of imminent dangers and pitfalls ahead. It makes sense, right? Our brains are wired to first and foremost detect change and warn us that something unusual and dangerous might lie ahead.

Retirement is a major transition for most people. You are leaving your previous life behind but what are you transitioning to?  Do you know for sure? 

Anytime we do something new we face these “warning” voices – from "be careful and don’t jump ahead too far" to "run away and hide". That little voice is our primitive brain protecting us from possible danger, but sometimes it is doing nothing more than preventing us from all the good that might be on the other side of fear and uncertainty.

Change involves discomfort. Very few people like being uncomfortable, but overcoming it is the only way forward during periods of personal transition. Retirement is no exception and for many people it brings out many fears – some acknowledged upfront and some hidden. 

Fear holds us back from new beginnings.  We might pull back from going full throttle into our new phase in life. We might endlessly wait for the "right" time. We may just become paralyzed. We may never get to enjoy the retirement we envisioned for ourselves and that in itself would be scary, right?

We all have fears, but we have a choice how to deal with them. Ignoring them does not work. They just keeps coming back. Always adopting a sunny attitude regardless of what may be going on in our lives also does not work for most people. Rather we need ways to manage our fears because they are always there. They will dissipate at times but come back with a vengeance when we least expect them.

When you retire from your work you don't also retire from life. Your personality and identity don't change overnight. Your emotions certainly don't.

What you're feeling in retirement is probably not that far off from what other people are feeling. Let's take a look and you tell me if any of these fears are yours as well.

  • Physical deterioration
  • Running out of money
  • Mental decline
  • Becoming a burden on family
  • Feeling invisible

Let's explore these further,

Fear #1 - Physical Deterioration

Every day we get a bit older. We all know that. What we all fear the most is not the inevitable physical decline, but a sudden deterioration in our physical condition that would seriously impact our lifestyle. It could be a sudden illness, or falling down and breaking a hip.

 
What really petrifies people is the possibility of becoming permanently dependent on other people for daily living.  We fear becoming incapable of leading the type of life that we had envisioned in retirement. 


People near or in retirement think about physical decline a lot more than young people. After all we have already seen some signs that we're no longer what we used to be.


We all know how the game is going to end but is our only choice to live in fear for the next two or three decades?

The Alternative

Have you thought about how you're aging? Is there anything you can do to improve your health? Are you willing to take control of the aging process?

 
Have you come up with your own health plan besides someday eating better and exercising more? Your health is an investment in the quality of your life. Ask yourself, is your lifestyle focused on nutrition, physical activity, mental stimulation, adequate sleep, and maintaining close social connections? Yes, all those things not just one or two or what comes easy to you.

 
Your mind, body, and spirit are all related. For starters, do you have an exercise plan emphasizing aerobic, strength and flexibility activities? All too often people do one type of exercise and forget about the others. There’s a saying in the fitness world that aerobic fitness allows you to live longer but strength and flexibility allow you to live better. You probably want both.

 
Maintaining physical health is not just about maintaining your body parts in good order. Physical health is also highly correlated with your emotional makeup.


The best way to manage your fears of physical decline is to be proactive about your health. Invest in your health.  

What You Can Do:

  • Adopt a healthy eating plan focused on nutrition and portion control  
  • Combine aerobic, strength and flexibility exercises
  • Sleep at least 7 hours a night and allocate time for daily recovery

Bank Owned sign in lawn

Fear #2 - Running out of money

Yuk, do we really have to talk about money again? 


Nobody likes to talk about money, but in this day and age of being responsible for your own retirement the topic of money is always front and center. As much as we would like to just assume that everything will be fine we all know that when it comes to money issues we can’t simply ignore our fears and stash them away.


Money has many emotional connotations for people, but at the end of the day money is what allows us to pay for our lifestyle. Some people enjoy a Spartan lifestyle requiring minimum financial resources. Other people have become accustomed to a more expensive lifestyle requiring a fair amount of savings and additional sources of income. Where do you fit in? Could you be happy in retirement without massive financial resources? 

 
The fear of running out of money cuts across the board whether you are wealthy or not, but is magnified in today’s world as people live longer. In fact, your retirement could last three decades or longer.


In the US for example, life expectancy has increased by four years in the last century while the average actual retirement age has remained constant at 62 years of age. As people retire they should expect to fund a longer period of time in retirement than maybe they had anticipated. Running out of money is a real fear.

The Alternative

The fear of running out of money is real and needs to be addressed by today’s retirees through realistic financial planning and a sustainable income generation investment strategy.


Without the security of a steady paycheck there is a heightened need to stay on top of your finances. Maintaining control over your discretionary spending is a must, but equally important is structuring your investable assets to deliver an income stream that grows with inflation and does not unduly expose you to wild stock market gyrations.


If you haven’t done a financial plan don’t procrastinate. Small leaks can sink even the best looking ship. If you need help hire a financial advisor to spec out what type of financial health you’re in and design an income strategy to fund a sustainable lifestyle. It doesn’t have to be complicated or scary.

 
The best way to confront your fears is to know where you stand. If you do this early enough you will have more options at your disposal. At the very least make sure that your sources of income – social security, pensions, and other income – are in balance with your ongoing expenses. 

What You Can Do:

  • Monitor your expenses and identify small "leaks" that are eating away at your savings
  • Develop a plan to generate sustainable income from your investments
  • Make sure that your money grows faster than inflation

Fear #3 - Mental Decline

A huge fear among today’s retirees is the possibility of losing one’s ability to make good decisions.


While people understand that with  aging comes some cognitive decline, the real (unspoken) fear is about contracting early stage dementia or Alzheimer’s.

 
I know of people whose relatives have suffered from this fate and they will do anything in their power to lower their chances of getting this dreaded disease.

 
Mental decline is, however, not just about terrible diseases like Alzheimer’s. It may be about simple forgetfulness or staying mentally sharp to keep living independently.


A declining mental outlook is hugely embarrassing to most people. They hide it. They stop doing things that once gave them huge satisfaction.  The fear of not being able to figure out things that once upon a time seemed straightforward can lead to social isolation that in itself is hugely damaging. 

The Alternative

Medical research has highlighted the fact that as we age our thinking becomes less abstract but more concrete and complex. But as we all know older people tend to do less well when stressed and under time pressure. This is because aging affects how quickly and efficiently we process new information.


The best antidote to declining mental capabilities is to exercise your brain. How?

 
One way is by participating in new learning opportunities that challenge your brain. For example this could involve learning a new language or technical skill. It could involve playing board games such as chess. 


Physical exercise is also a great preventative approach as is simply staying engaged in the world by keeping up with current technology and social trends.


Activity and movement are highly correlated with brain health.  Keep on moving!

What You Can Do:

  • Stimulate your brain by learning something new
  • Keep up with new technologies designed for healthy aging 
  • Minimize the consumption of alcohol 

Woman Checking Her Temperature

Fear #4 - Becoming a burden on family

People do not like to discuss this fear especially with immediate family members. It’s often too deep and painful. It's better to ignore the obvious until the very end.

This fear is based on role reversal. Parents are used to taking care of their children regardless of how old they are. It’s very hard to break out of this pattern, but the time will come when either because of physical or cognitive decline the roles of parent-child reverse.

Letting go (by the parents) is an admission of decline. For some people the decline is sudden and precipitous and for others it is slow but steady. Either way asking for help may be difficult especially if support is not a one off event.


Support may be financial, emotional or simply related to everyday living tasks. For example, when the day comes when a person can no longer drive they will become totally dependent on the goodwill of family or strangers for getting about.

People hate inconveniencing strangers almost as much as they hate imposing on family members. It does not feel natural to them. It contradicts their sense of individuality. It implies a give and take but they feel unable to give much in return.

The Alternative

Asking for help is not easy for many people. There is pride involved, but there is also the knowledge that people today lead very busy and stressful lives of their own.

Asking for help may be seen as an admission of decline. Nobody feels good about declining physical or mental health so asking for help becomes a much bigger issue than it should. 

Turn the tables before it's too late. If a friend or family member is struggling take notice and offer your help. Oftentimes the issue is about awareness – noticing the little things that a person may be struggling with and being proactive and sensitive about offering help. Model how you would want to be treated because at some point that will be you.

Maintaining close family and social connections is important. Close connections are often the first to notice clues that something may not be all ok and that help may be required. Tiny issues compound into big issues. Better to prepare ahead of tie than to have to deal with a crisis.

What You Can Do:

  • Manage expectations - talk about it your needs openly with your family
  • Cultivate healthy relationships in your community
  • Minimize the burden by hiring  help - in-home care, maintenance, transportation, etc

Susan Jeffers

-Psychologist-

"Security is not having things, it’s handling things"

Fear #5 - Feeling invisible

We all want to feel that our lives matter.  When we're working and raising a family we feel needed. We feel that we matter, but when we retire we loose some of that sense of purpose. There is a void.


We live in a society that prizes youth above all else. Retirees often feel youthful and vibrant inside despite a couple of wrinkles here and there, but society often implicitly sends messages that contradicts these inner feelings. The implication - your best days are over and you need to move over to make room for the new.


Corporations also exhibit ageism further exacerbating this disconnect between how people feel inside and how society views them.


The dirty secret of unemployment statistics hides the fact that past a certain age (typically 50 in the US) younger employees and employers start looking at older workers in a different way and in the event of a job loss it is incredibly hard to regain similar employment.

The Alternative

It is easy to start feeling invisible. “Age is just a number” is a frequently heard saying and it is very true but you are often asked to prove it.


There are always possibilities for re-invention. You may need to switch your framework a bit, but the wisdom accumulated through years of hard work and life experiences creates context and perspectives that only time can provide.


Use that wisdom to address today's concerns not those of your generation. Be of value. You might, for example, teach, mentor or volunteer. Even better do all three at the same time.


The transition to a new you that feels relevant and valued in today’s society may take time and deep introspection.  It requires an open and flexible mind. It requires adopting a new identity devoid of resentment and ego. Figure out how you can be of value in today's world.

What You Can Do:

  • Get a makeover (that applies to men as well) to look your best 
  • Focus on the present by making trips down memory lane less frequent
  • Make it your mission to be of value - plenty of people could use your help

Susan Jeffers in her book “Feel the Fear … and Do It Anyway” talks about five “truths” to keep in mind about fear. Here they are,

  • The fear will never go away as long as I continue to grow
  • The only way to get rid of the fear of doing something is to go out and do it
  • The only way to feel better about myself is to get out … and do it
  • Not only am I going to experience fear whenever I’m on unfamiliar ground but so is everyone else
  • Pushing through fear is less frightening than living with the underlying fear that comes from a feeling of helplessness

I love these "truths" so much that I have them pinned right by my desk at work. They remind me that we all have fears but we must manage them in order to move forward.

Here's another quote that I also keep nearby,

les brown

-motivational speaker

"Too many of us are not living our dreams because we are living our fears"


The Key to Beating your Fears

  • Learning how to deal with fear is a life skill that needs to be cultivated. We have a choice how to deal with fear - ignoring it just postpones the day of reckoning. Small fears can compound into big fears draining  all your energy.
  •  Life transitions such as retirement involve heightened levels of fear – fear of the unknown, our own mortality, financial security, the loss of identity, what our purpose in life is, what we are good at, etc.  Transitioning into retirement can be scary. 
  • Fear holds us back from new beginnings.  It makes us less adventurous.  It makes us wait for the "right" time to do things.  It robs us valuable time and energy from the retirement we envisioned for ourselves.
  • The fear of something bad happening pales in comparison to the upside of living a life of fulfillment and purpose – too much of a focus on what can go wrong can keeps us from enjoying our retirement years.
  • The key to dealing with your fears is to confront them head on. You will always feel fear but how you deal with it will greatly affect the quality of your retirement. 
  •  Dealing with your fears will make you feel better and more in control. Way too many of our fears take up a disproportionate amount of space in our head if left unattended. Taking action is the key!

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4 Steps to Take Now to Make your 401(k) Spring Back to Life


According to the Investment Company Institute there were over 55 million active participants in 401(k) plans plus millions of former employees and retirees as of the end of last year. The amount of money is staggering at $5.3 trillion as of the end of 2017.

With the demise of traditional defined benefit plans, 401(k)’s provide the most popular way for individuals to save for their retirement. 401(k)’s are also the second largest source of US household wealth right behind home equity.

Given the importance of 401(k)’s to US household financial health you would think that plan participants would watch their balances like a hawk and actively manage their holdings.
Some people do, but the vast majority of people do not truly understand what they own or why. Most people know that the more they contribute to their 401(k) the higher their ending balances are going to be, but beyond that there is a lot of confusion.

Many people do not make 401(k) choices naturally. Many participants do not even know where to begin when it comes to:

  • What funds to select
  • How much to allocate to each fund
  • Deciding how much risk to take
  • Understanding how their 401(k) fits in with the rest of their finances

When given a choice, people usually start with the issue or problem that they perceive as the easiest to figure out, not necessarily the one of greatest importance.

Many people approach the problem of how to invest their 401(k) in a simplistic manner.
Many 401(k) participants start off by selecting funds. For most participants this is not an easy choice, but in comparison to the other issues this one appears manageable.

But sadly, participants are getting it backwards by picking funds first. They are not framing the problem correctly.

Picking funds before figuring out your goals and objectives is like picking furniture before you know the size and shape of your dining room. It might work out but it would involve a lot of luck. Do you want to count on luck when it comes to your financial future?

Tangle of computer wires in office

A different way of addressing the challenge is to start the other way around. Start with the end goal in mind. Reframe the problem to first figure out what you are trying to do.

You want your 401(k) to work for you and your family, right? Sound like a better starting point?Without knowing what you are trying to do and what really matters to you putting money into your 401(k) loses meaning.

First figure out for yourself why you are taking money out of your paycheck to put into your 401(K). What is your “why”?

The answer may be obvious to you, but when money gets tight due to some unforeseen life event you will be glad that you have a tangible picture for its ultimate use.

Visualize what you are going to do with that money. Is it for a retirement full of adventure? Is it for buying that dream sailboat that you’ll take around the world? Or, is it simply to preserve your lifestyle once you retire?

Money has no intrinsic value if you don’t spend it on things that matter to you and your family.

Richard DeVos, Founder of Amway

Money cannot buy peace of mind. It cannot heal ruptured relationships, or build meaning into a life that has none.

If starting with the end in mind makes sense to you, let's take a look at the four steps to take now to make your 401(k) spring back to life.


Hint: Start With the End in Mind

step 1

Outline your main financial and  life goals

step 2

Determine the level of risk you need and are willing to tolerate

step 3

Set your allocation between stocks, bonds, and cash

step 4

Pick your funds from the plan sponsor menu

Step #1

Outline your main financial and life goals

Visualize your goals and objectives for the type of life you and your family want to lead. Don’t just think about your retirement – think as broadly as possible.

 
Close your eyes, visualize, pour a nice glass of cabernet for you and your partner before you have the “talk”, write it down in your journal – whatever approach gets you out of your everyday busy persona and makes you focus on what you really want out of life.


How do you want to use your money to accomplish this lifestyle? Maybe you and your spouse want to engage in missionary work in 10 years. Maybe you also need to fund college expenses for your children? Maybe you see a lakefront house in the near future? There is no cookie cutter approach when it comes to people’s dreams! It’s up to you to make them up.


Your 401(k) assets are just one component of your household wealth. Think about your other assets and financial obligations. And don’t forget to include your partner’s or spouse’s.

 
Your house, your emergency fund, investments in mutual funds, possibly a little inheritance, company stock. Almost forgot, your spouse’s 401(k) and that condo that he/she bought before you met. Take a comprehensive inventory of your assets.
How much debt do you have? That is part of your financial picture as well. Do you anticipate paying your mortgage off in the next few years?


Wealth managers talk about a concept called the household balance sheet. It’s the same idea that financial analysts use when evaluating a company. In the corporate world you have assets, liabilities and the difference is net worth. In your own world you have assets, obligations and unfunded goals, and net worth is the difference.


Sounds a bit harsh when it involves you, right? Don’t take it personally. The key idea is taking an inventory of what you own, what you owe and then matching that up to your goals and aspirations.



Spinning Gyroscope on Wire

Step #2

Determine how much risk you need to take and are comfortable with



The whole idea of saving and investing is about making your goals and aspirations a reality. If you already have enough assets to fund your desired lifestyle into perpetuity then you don’t really have to worry too much about investing. Just preserve what you got!


If you are like most people, you need to make your investments work for you. You need a return on your assets.


It’s a good idea to be realistic about goals and objectives.


  • Are your goals reachable?
  • Are your financial and life goals aligned?
  • Are your goals consistent wit the vision you have for your life?


Your answer will dictate how aggressive you will need to be in your investment strategy. The more ambitious (financially speaking) the goal the more you will have to reach for high returns. 

  • If your goals are a stretch you need high return/high risk investments – be ready for a volatile ride and many highs and lows. Your emotions will range from elation to total despair. Removing the emotional component from your financial life will be critical to your success.
  • If your goals are within reach using "normal" asset class return assumptions you need a moderate return/moderate risk portfolio – you will still experience fluctuations in your portfolio that will leave you feeling anxious at times, but the periods of recovery will more than make up for the periods of stress
  • If your goals are a slam dunk given your financial resources, you are lucky and you will only need low return/safe investment strategies – your portfolio values will not fluctuate much in the short-term but your portfolio will also not grow much in size over time.  Be ready to deal with FOMO.

To some extent this is the easy part.


There is a link between risk and return in the capital markets. Higher risk usually translates over long periods of time into higher returns. Equities do better on average than bonds and bonds in turn do better than money market investments. So far so good.


Figuring out the required rate of return to fund your goals and objectives given your resources involves math but little emotional contribution.


But what about your emotions?


This is the tricky part. Many people are able to conceptualize risk in their heads, but are entirely unable to deal with their emotions when they start losing money.
They think of themselves as risk takers but can’t stand losing money. They panic every time the stock market takes a dip. It does not matter why the market is tanking – they do not like it and run for the exits.


But an honest assessment of both your need to take risk as well as your comfort level with investment fluctuations is necessary in managing your long-term financial health. You will see massive cracks if these two dimensions of risk are not aligned.


Let’s examine a simple situation where we classify your need and comfort level with investment risk in three states: low, medium and high.


The table below lays out the possibilities.


Ideally, your two dimensions of risk will align. For example, if your need for risk is low and your comfort level with taking risk is low you are all set. Same if you need a high risk/high return strategy to meet your goals and objectives and you are comfortable experiencing significant fluctuations in your portfolio. Your need for risk and comfort are aligned!

Need

versus Comfort

Needs to be Conservative

Moderate Need 

Needs to be Aggressive

Low Comfort with Risk

OK

LIVING IN FEAR

NOT SUSTAINABLE

Medium Comfort

FOMO

OK

LIVING IN FEAR

High Comfort with Risk

NOT SUSTAINABLE

FOMO

OK

The real problem is when the two dimensions of risk are not aligned. 


You’ll need to resolve any differences or misalignments as soon as possible to regain any hope of financial health.


Let’s say you are really risk averse. You fear losing money. Your worst case scenarios (visions of you becoming a bag lady, eating cat food) keep popping up in your nightmares. If your goals and objectives are ambitious in relation to your resources (high need for risk) those nightmares will not go away and you will live in fear.

 
You can do one of two things – learn to live with fear or, scale back your goals and objectives. There is no right or wrong answer – it’s up to you but you must choose.


What if you are comfortable taking on lots of investment risk? Would you like a low risk/low return portfolio? Probably not. In fact, such a portfolio would probably drive you crazy even if you did not need higher returns.

 
People comfortable with investment risk frequently suffer from fear of missing out (FOMO). They think that they should be doing better. They want to push the envelope whether they need to or not. It's part of their personality - they want more, more, more.

 
FOMO is as damaging of an emotion as living in fear. Both states spell trouble. FOMO should not influence your investment decisions.


Life is about balance. Investing is no different.


Balance involves figuring out how much risk you need to take versus how comfortable you are with taking that risk. Balance does not mean never taking risk but rather taking an appropriate amount of risk given your situation and goals.

Step #3

Set your asset allocation mix(split between stocks, bonds and cash)

Sounds like a mouthful, right?


Let’s put it in plain English. First of all, the term asset allocation simply refers to how much of your investment portfolio you put into the main asset classes of stocks, bonds and cash/bills.


Sure, we can get more complicated than that. In our own research we use ten asset classes, but in reality breaking up the global equity and bond markets into finer breakouts is not critical for the average individual investor.

 
Figuring out the right range of stocks, bonds and cash is much more important than figuring out whether growth will outperform value or whether to include an allocation to real estate trusts. Be patient - do the micro fine tuning later once you have figured out your big picture asset allocation.


Let’s look at some possible stock/bond allocations. We'll focus on risk and return.


We are going to use information from data provided by Professor Aswath Domodaran from NYU. It covers US annual asset returns from 1928 to 2021. We are using the S&P 500 for stocks and a medium credit quality (Baa) portfolio for bonds. For cash - the safest asset - we use the 3 month US t-bill.

The top half of the table shows the performance and volatility of stocks, bonds and cash  by themselves.  

Stocks are the riskiest but also have the highest average return. Cash is the safest but does not yield much, on average. With historical inflation running, on average, about 3% there is not much real return in cash investments. Finally bonds are in between.  They carry some risk because companies may go bankrupt and default on their debt but, in general, they are much safer than stocks. 

From year to year there is tremendous variability in returns but for the sake of simplicity you can use historical risk and returns statistics as a rough guide.

Here are a couple additional points mentioning

  • If you need high risk/high portfolio returns and you can take the volatility go with a stock portfolio with average historical returns of 12%.  You should expect a bumpy ride. Expect negative returns one in every four years. 
  • If you only need low risk/low returns and are extremely risk averse go with cash investments returning, on average, 3.3%. This portfolio is probably just going to keep up with inflation so your wealth is probably not going to grow. 
  • If you have a medium tolerance for risk and medium need for taking risk then you will likely gravitate toward a portfolio of corporate bonds (Baa) that exhibit, on average,  negative returns only 15% of the time.
  • If you want a little of everything consider a multi-asset class portfolio composed of stocks, bonds and possibly cash. Most 401(k)'s provide this option prepacked either as a "balanced" mutual fund or, more commonly, as a "Target Date" fund.  
  • There is an infinite number of combinations of asset class weights – the three asset allocations in the bottom panel of Table 1 may very well apply to you depending on your risk tolerance, need for return and time horizon
  • The industry standard, the 60% stock/40% bond allocation has over this 1928-2021 period yielded a 10% return with a 13% volatility. Historically, you lost money 21% of the years. 
  • Lower allocations to stocks result in lower levels of risk and a commensurate drop in average returns.
  • Based on these risk and return tradeoffs you'll need to decide on a target mix of stocks, bonds and cash that not only meet your needs but also allow you to sleep at night.   

Step #4

Finally! Go ahead and pick your funds from the lineup in your 401(k)

Yes, this is typically where people start.


Many times people pick a bunch of funds based on a friend’s recommendation or simply based on the brand of the investment manager. Rarely do people dig deep and evaluate the track record of funds.

 
A lot of people pick their funds and declare victory. They are making a huge mistake. They are not framing the problem correctly.


The problem is all about how to make your 401(k) work for you in the context of your goals and objectives, your resources and your comfort with investment fluctuations.


Picking funds is the least important part. You still have to do it but first figure out what matters to you, your need and comfort with risk and your target stock, bond, cash mix.


Once you have your target asset allocation go to work and research your fund options. Easier said than done, right?


Here are some fund features that you should focus on.


  • Passive or Active Management – a passive fund holds securities in the same proportions as well-known indices such as the S&P 500 or Russell 2000. An active fund is deliberately structured to be different from an index in the hope of achieving typically higher returns
  • Fund Style – usual distinctions for equity funds are market capitalization, value, volatility, momentum and geographic focus (US, international, emerging markets). For bond funds the biggest style distinctions are maturity, credit and geographic focus
  • Risk Profile – loosely defined as how closely the fund tracks its primary asset class. Funds with high relative levels of risk will behave differently from their primary asset class. Accessing a free resource such as Morningstar to study the basic profile of your funds is a great starting point.
  • Fund expenses – these are the all in costs of your fund choices. Lower costs can translate into significant savings especially over long periods of time. In general, index funds tend to be lower cost than actively managed funds


Understanding what makes a good fund choice versus a sub-optimal one is beyond the financial literacy and attention span of most plan participants.

 
For most people a good rule of thumb to use is to allocate to at least two funds in each target asset class.

 
Let’s make this more concrete. Say your target asset allocation is 60% stocks and 40% bonds. Most 401(k) plans have a number of stock and bond funds available.

 
What should you do?


A minimalist approach might entail choosing an S&P 500 index fund and an actively managed emerging market equity fund placing 30% in each. This maybe appear a bit risky to some so maybe you only put 10% in the emerging market fund and 20% in a US small capitalization fund. The key point is that having more funds is not always better!

 
Same on the bond side where you might allocate 20% to an active index fund tracking the Bloomberg US Aggregate index and 20% in a high yield actively managed option.

 
Let your fund research dictate your choice of funds. You should keep things simple.
Know what funds you own and why. Keep your fund holdings in line with your asset allocation. Spreading your money into a large number of fund options does not buy you much beyond unneeded complexity.


Most of your 401(k) performance will be driven by your target asset allocation anyway.


Picking funds that closely match the risk and return characteristics of your asset classes (say stocks and bonds) is good enough. Trying to micro-manage the selection of funds will not likely lead to a huge difference in overall portfolio returns.

TL;DR

  • The task facing you in managing your 401(k) may seem daunting at times. You may feel out of your own depth.  You are not alone but if you reverse the usual way in which most participants manage their 401(k)’s you should gain greater control over your long-term financial health.
  • Start with the end in mind. What is this money for? Think about your life goals and objectives. Depending on your resources, you will need to figure what type of risk/return portfolio combination you will need as well as how comfortable you are dealing with the inevitable investment fluctuations.  
  • Based on your needs and risk profile the next step is figuring out how much to allocate to stocks, bonds and cash-like investments. That process is called asset allocation. It is the main driver of your future returns.
  •  Do not pick your funds before these three steps are done.  Keep it simple when choosing your funds. You have figured out the important stuff already. Pick at least a couple of funds in each of your target asset classes by performing some high level research from sites such as Morningstar or MarketWatch. Keep in mind that more funds do not translate into higher levels of diversification if they are all alike. Know what you own.
  • If this is all just too much for you, consider hiring an investment advisor that can perform a comprehensive analysis of your asset allocation and fund choices in relation to your stated goals and objectives while also keeping your expressed risk preferences in mind. The analysis will set your mind at ease and point you in the right direction.  

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3 Mistakes Inexperienced Investors are prone to make in a Stock Market Crash


Newbie Investors have been cropping up everywhere since the advent of the Covid-19 virus. Some people refer to these investors as the Robinhood or Reddit crowd. This new group of market participants along with more established Do-It-Yourself (DIY) investors do not rely on investment professionals to manage their money.

Newbie’s, for the most part, believe that current investment methods are obsolete and behind the times. They see little need for using more traditional ways of managing money. They prefer to pull the trigger themselves and in fact derive great satisfaction from beating the establishment. They are the new kids on the block.

DIY investors, on the other hand, have been around for a while. There was a big jump in DIY investors around the time of the Great Financial Crisis of 2008. Many DIY investors used to have professional advisors manage their investments but became disillusioned with the results and concluded that they could do as good or better job than their advisors.

Many Newbie and DIY investors have taken the time to educate themselves about investing. Not everybody requires somebody to hold their hand to achieve superior results, but many do. Many Newbie and DIY investors have never experienced a gut churning market meltdown such as 1987, 2000-2002 and 2008. They have experienced mild corrections that quickly reverted back to an uptrend. They have lived their investment lives in a low volatility environment with declining interest rates and hardly perceptible inflation.

  • What if market conditions go from benign to all of a sudden nasty?
  • What if volatility spikes up and stays high for a while?
  • What if widespread panic sets in?

How will inexperienced investors likely react?

Remain Cool and Collected ?

Doubtful!

Become Nervous and Fearful?

Most Likely!

After all investors are human and when humans are involved emotions take over especially during periods of market stress. Your head may be saying stay the course and don't panic but your stomach is churning and your palms are sweaty. 

Professionals are not immune from experiencing these emotions. Nobody likes seeing red on their screens!

When markets tank the primary investor emotion is raw, gut-wrenching fear

  • Fear of losing control of one's destiny
  • Fear of the unknown
  • Fear of a loss of economic standing

Fear in turn is followed by regret and self-doubt

  • Regret for not being smarter
  • Regret for not having done the necessary research
  • Regret for having been so greedy and short-sighted
  • Regret for following the herd

These are all human emotions felt by amateur and professional investors alike. The difference is that professionals usually keep a little space between the time their palms become clammy and the actions they take. Enough time to reflect on past periods of stress and the lessons learned. Enough time to rationally respond (or not) to the fear of the masses.

Only experience and applied know-how stand between wanting to chuck it all to relieve the fear and a clear mind focused on both the opportunities and risks of the situation.
Fear and its close cousin, regret, create mistakes if you let these emotions drive your investment decisions.

Inexperienced investors tend to do well when capital markets exhibit low volatility and the trend in price is well established. Everybody loves up-trending markets that don’t fluctuate much. But as Humphrey Neill, a famous contrarian investor, used to say “Don’t confuse brains with a bull market”.

The analogy I like to use is that of a pilot. When everything is calm even a novice will look good. But when the friendly skies become turbulent, a novice pilot will likely tense up and the odds of making a mistake increase significantly.

Inexperienced investors face the same situation. During periods of calm, portfolio decisions will come easily. The cost of a poor decision is not likely to have major consequences in a benign environment.

But when the capital markets get dicey, the implications of one’s actions increase dramatically. A poor decision could decimate the value of your portfolio and seriously harm your overall financial health.

Inexpereinced investors are ill-equipped to deal with extreme capital market stress

Stock market corrections are not fun for anybody, but experienced investment managers have the real benefit of having seen a movie of the same genre before. Corrections are often a mere blip on a stock chart but crashes are something else. 

As a professional investor, I have lived through the 1987, 2000-2002, and 2008 stock market crashes. None of these were fun but I learned valuable lessons in each of these crisis. I mainly learned not to panic. I also learned that at times one must course correct if the fundamentals warrant it.  Standing pat might sound noble but could also seriously harm your pocket book!

Many DIY investors and certainly the Robinhood/Reddit crowd have not seen a real crisis in their investment lifetimes. The Covid-19 market event was a mere correction, not a crash as the market had pretty much recovered by year-end 2020. While everybody can read about stock market crashes unless you live through such a period it is hard to truly understand their impact both on your pocketbook but more importantly on your psyche.

A crisis such as 2008 is extremely disorienting even for professional investors, but the advantage that experience and knowledge of capital market behavior affords is a game plan honed by the school of hard knocks.

Without the benefit of having lived through previous periods of real capital market stress and the knowledge of how markets typically behave, inexperienced investors are at a significant disadvantage.

The potential for mistakes goes up exponentially in a crisis especially if you're an inexperienced investor

Mistake #1

Selling everything in a panic

No questions asked, just get rid of everything that is taking a hit before it gets even worse.

 

Taking action by selling everything may give you a sense of relief. But making decisions in a highly charged emotional state is asking for trouble.


If the decision to sell is based on solid research and is well thought out, fine. But if it is based on impulse and an immediate need to get rid of the stress then it is most likely that the portfolio was not appropriate for the individual in the first place. Investing comes with volatility, there is no way around this!


Oftentimes when an investor sells in a panic the most troubling decision is when to buy in again. Even worse if the decision to sell turns out to be wrong, the investor will endlessly question themselves and lose confidence in their ability to navigate on their own.

 
Inexperienced investors tend to focus on the initial portfolio composition or asset allocation but often fail to plan ahead should market conditions change. And if there is one thing that holds true is that change is inevitable and an ongoing part of financial markets. Planning ahead for changing market conditions is an integral component of a well-designed investment plan.


Fortunately, most inexperienced investors know that impulsively selling everything in a panic is not a good wealth creation strategy. But don’t kid yourself – in a market meltdown you will want to sell everything and more! And that is when regret kicks in.


You will have to control your emotions and have the stomach to weather the inevitable periods of market turbulence if you hope to become a successful long-term investor.

Mistake #2

Freezing up 

Most market corrections are short-lived and while painful in the short-term they barely register on the long-term map. For example, in 2020 during the onset of Covid-19 we experienced a deep correction in the spring but by fall the market had recovered most of its losses.

 
No harm, no foul! Doing nothing or standing pat works just fine when markets recover quickly.


The bigger problem for investors is when corrections take on a bigger life and become outright market crashes. For example the S&P 500 was down three straight years from 2000 to 2002. What do you do when the roof seems to be caving in?

 
Many inexperienced investors close their eyes and pretend that this is not happening to them. They freeze up and choose to ignore reality.


This is not an abnormal reaction at all for us humans, but we also know that small problems many times lead to big problems if we do not address the underlying issue. I know of many people that on paper were multimillionaires during the Tech boom of the late 90’s only to wake up three years later to almost nothing.


Wishing the problem away does not work. Behavioral finance researcher have shown that investors tend to hang on to their losing investments way too long. The flipside is that research has also shown investors to sell their winners way too soon. This effect is known as the disposition effect.

 
The price of financial assets such as stocks is a function of fundamentals (growth and profitability), the fair price of those fundamentals (investment multiples) and the sentiment of buyers and sellers.


During a period of crisis, the tendency by inexperienced investors is to focus almost exclusively on sentiment. When sellers want out now and buyers are scarce the price will automatically come down. Not a fun place to be for any of us.


During a crisis all you see are falling prices and investors ready to jump off the cliff in despair. Before you join them ask yourself if there is any real economic information in how investors are feeling. Is the fear justified by a sharp drop in fundamental values?

 
Experienced investors while not immune to the same feelings of fear will look at the underlying fundamentals and the value of those fundamentals. Experienced investors know that investor sentiment is fickle and lacks predictive ability.


  • Has something changed recently to warrant this drop in market values? 
  • Are growth rates and profitability permanently impaired, or is the market over-reacting?
  • Are investors reacting to the perception of market over-valuation? 


These are all questions that require some real expertise and most importantly an understanding of context.


There is no cookie cutter way to analyzing market action. The only thing you got in a crisis is experience in similar conditions coupled with knowledge of historical market behavior. That combo is most valuable in a crash scenario.


Inexperienced investors often lack an understanding of context and an assessment of prospective fundamentals in the face of wildly fluctuating capital market conditions. They thouhgt that investing was easy but all they have seen is a rising tide.


The tendency by many investors is to stand pat, but what if changing market fundamentals require a change in portfolio positioning?

Mistake #3

Not adjusting to changing risk levels

A frequent mistake made by inexperienced investors is to focus almost exclusively on returns and ignore the risk and correlation structure of their portfolios.


In fact, it’s been my experience in evaluating thousands of new client portfolios that inexperienced investors are often extremely concentrated in one or two themes without realizing the risk of such an approach. These themes carry their own risk profile which at best is poorly understood and in most cases not even considered.


I will go out on a limb here by saying that very few amateur investors understand the risk profile of their investments. They may understand why they hold what they own but can’t quantify the risk of their overall investment.


Do many newbie investor even understand the concept of investment risk?
Ignoring changing asset volatility and correlation is a serious mistake made by many non-professional investors.


By ignoring the volatility structure of portfolios investors are foregoing some of the lowest hanging fruit available. As Nobel Prize Winner Harry Markowitz once said “diversification is the only free lunch provided by capital markets”.


As capital markets change over time so will the risk characteristics of a portfolio even if the portfolio is rebalanced to static weights. 


Stock volatility, in particular, can move quite a bit around. Bond volatility while still variable shows much lower variability. And, correlations between stocks and bonds can move between positive and negative values implying large changes in diversification potential for a portfolio.


The image above shows a snapshot of the 20 day rolling volatility of the S&P 500 and the Bloomberg Aggregate Bond Index. The volatility of stocks has fluctuated between 7 and 21% in the last year. That’s huge.


Similarly the volatility of bonds has also shown a wide range from 3 to 6% on an annualized basis. 


Capital markets are not static. Even if you rebalance your portfolio as advocated by many advisors your portfolio volatility will fluctuate massively during periods of market stress.


Say, an investor has a portfolio composed of 60% US stocks and 40% US Bonds. The investor diligently rebalances this portfolio so that the weights stay in sync.


What would this 60/40 portfolio look like in terms of volatility?


Using the last year as a guide the average volatility of this 60/40 portfolio would be about 8%. Assuming that the average volatility would not change much would, however, be a mistake. The range of volatility goes from 4% to 13%.

Even the old standby 60/40 portfolio exhibits wildly fluctuating levels of portfolio risk. A 4% volatility level implies a much lower level of potential downside risk compared to a portfolio with a volatility of 13%. Experienced investment professionals inherently understand this and often seek to target a narrower pre-defined range of portfolio volatility.

I have never heard of Newbie or DIY investors that construct portfolios targeting an explicit range of risk. They focus almost exclusively on returns. The often hidden assumption is that over the long-term asset returns, volatilities and correlations will gravitate toward their “normal” levels. These assumptions are not supported by the empirical evidence.

For inexperienced investors, changing levels of volatility and correlations can cause significant changes to the risk/returns characteristics of their portfolios. For example, volatility tends to spike up during periods of capital market stress and remain low when markets are trending up.

Also, correlations among investments within the same asset class (broadly speaking equities, bonds and alternatives) tend to also jump up during periods of crisis leading many to question the benefits of asset diversification.

What investors should be questioning instead is why they did not re-adjust their portfolios to reflect the changing conditions?

Conclusions

  • In an environment of zero trading commissions there will always be a temptation for inexperienced investors to jump in and try their luck. These investors will do well when markets trend up and volatility remains low. Their portfolios may even beat those managed by professionals. But there is a hidden “cost” that inexperienced investors may be incurring on their own that often rears its ugly head during periods of capital market turbulence. 
  • We are all human and we suffer from the same biases and fears. The difference is that experienced professional investors have the advantage of having seen similar periods of capital market stress before and possess a more nuanced perspective of capital market behavior.
  • Inexperienced investors tend to make three types of mistakes during a crisis – they chuck it all in a panic, they freeze up and do nothing, or they ignore changing levels of portfolio volatility.
  • Professional investors while prone to the same fears as the Newbie and DIY crowds are better positioned to focus their attention on the fundamentals of investment performance -growth, profitability & valuation – that ultimately drive portfolio values.
  • Experience and knowledge gained over many market cycles is at a premium when dealing with the emotions of fear and regret that are most strongly felt by new market participants. 

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How well do you know retirement?

Champagne bottle in ice bucket

The Setting

You've been looking forward to retiring for ages. You have mentally switched off from work and now spend your day day dreaming about all the fun and games you're going to enjoy during your new found freedom.


You can't wait and then it happens. You finally retire. You might even have a small party at work to celebrate. Your neighbors are jealous. Your landscaper is nervous.

Your spouse is petrified!


Even you start having some doubts. The only one truly happy is your dog.


You realize that retirement is something new. It's a transition to something else. What exactly, you don't know, but it must be good because everybody is doing it, right?


A couple of months go by. It's really nice not having to wake up at 6 AM  and slug through the morning commute.  But there is something missing, a void that you didn't expect. Your old HR manager certainly did not tell you that this would happen. 


What is it? Is it just me? You start asking yourself questions aloud as you play your 13th round of golf (over the last 2 weeks). Now even the caddy looks perplexed which in turn makes you anxious and your game suffer.


  • What did you expect? 
  • Did you really know what you were getting yourself in?
  • Or, maybe you assumed some things that just were not true?

Retirement is a huge transition. Maybe your journey needs to start off with shedding some commonly held assumptions about this next phase in life.


Here are five often held assumptions that might be holding you back from truly enjoying a new beginning to your life in retirement. 


You cant' teach a dog new tricks, right?

You've always been this way, right? Why should you change at this stage of the game?  


A lot of people hold this opinion of themselves and others. In fact it is not unusual for people to look at others the same way they did many years ago.


Have you ever had the feeling of going to a class reunion and still thinking about people in the same way you did back in high school?

Perspective Change #1 - You decide who you want to become

Some parts of people’s personality remains the same but there is no reason why people can’t grow and learn new ways of being. You can too. Research on brain plasticity supports the idea that people can change and learn new things even at an advanced age.

 
You don’t have to assume that the way you think and behave is fixed at birth. Plenty of research confirms our great ability to adapt and change our thoughts and behaviors over time.


What type of person do you want to become? Is your old identity holding you back?

I know all about retirement – I saw how my parents did it

Of course that is one approach, but circumstances have changed dramatically even from a decade or two ago. The world has changed and so have the range of possibilities.


Chances are your parents might have had a pension that supported their lifestyle. Unless you are one of the lucky ones you probably have to rely on a combination of your savings and social security to fund your lifestyle.

 
Chances are that the type of lifestyle you parents sought in retirement was quite different to what most people today would find interesting.


Am I right? 

Perspective Change #2 - It's up to you to design your lifestyle

Retirement today is a la carte. You decide what works for you. The options are almost infinite.

 
With more options comes more complexity. You’ll have to figure out what lifestyle works for you. You’ll have to figure out how to turn your portfolio into an income generating machine. You’ll have to figure out how to work on meaningful goals with your new found time. 


Retirement today requires planning ahead. It requires customizing a plan that works for you. It requires you to take action and not wait around for a cookie cutter lifestyle that no longer fits today’s world.

The quality of my retirement depends on the size of my portfolio

Financial security is important. After all you need to take care of your basic needs and not live in fear of not having a roof above your head or sufficient medical care.


You need money to enjoy your journey, but money is not enough to pursue a life of joy and fulfillment.


Money can't buy you health or good social relationships. It can't buy you time when you're running out. 


Money is fuel for the ride, but do you know how much you need to take you where you want to go?  

Perspective Change #3 - You need more than money to be happy and fulfilled

Research by Nobel Price winner Daniel Kahneman highlighted that past a certain level of income ($75K in his study) having more money does not buy more happiness.


Having more money allows you to do more things and buy fancier homes and cars, but if you don’t use your time wisely and surround yourself with family and friends you won’t see much incremental benefit.

 
There are many other dimensions to leading a fulfilled life in retirement besides just money such as your health, social connections, hobbies, work activities and lifestyle. 


A balance among all of these contributors of your happiness is essential.  Focusing just on money won’t do it. 

I have my financial plan in place and I now we are all set

Planning ahead is commendable and you have a huge head start compared to most of your peers. You probably worked with a financial planner or investment professional in evaluating your ability to fund your desired lifestyle.

 
You slugged through inputting all kinds of projected expenses, income, capital market returns, inflation, and tax rates. Then your financial professional ran thousands of Monte Carlo simulations to assess the probability of running out of money given some reasonable assumptions and you passed.


Congratulations!

 
In all likelihood you are probably headed to a financially comfortable retirement, but the problem with any sort of plan is that the real world has a way of intervening.

Perspective Change #4 - Even your best laid plans will need to be updated

Your plan while perfectly logical at inception may start looking a bit outdated if any of the assumptions (and there are many) on which the plan was build prove to be wrong.


Maybe inflation turned out much higher than expected, or the second home on Deer Island did not fetch what you expected a few years back when you formulated your retirement plan.


It could also be the case that stock market returns have been much lower than expected but your living expenses have actually turned out to be significantly higher due to a medical emergency and higher property taxes.

 
Not only are plans only as good as their execution, but plans also need to be updated to reflect changing circumstances as well as potentially new priorities on your part.


Planning for retirement is an ongoing process

Finally, I can now be happy!

Many people look at their job as what is preventing them from being happy. They somehow expect that everything will fix itself when they are no longer working fulltime.


"If only I did not have to work with such difficult people". "If only, I did not have to do sit in this sea of grey cubicles". Everything would be great!


Too many people wait for the ideal circumstances to present themselves before pursuing a life of joy and fulfillment. They expect the skies to miraculously  open up. 

Perspective Change #5 - Your circumstances do not dictate your happiness

Professor Sonja Lyborsmky has found that about half of your happiness level is pre-determined. She calls this your happiness set point. Her research shows that about 10% of your happiness is determined by circumstances and the rest (40%) is up to you and how you lead your life.

 
Your job is part of that 10% accountable to your circumstances – changing your job or quitting altogether will barely move your happiness needle on its own.

 
A more fruitful way to increase your happiness is to focus on that 40% under your control.  Your lifestyle and daily habits drive the quality of your life whether you're working or not. Don't use your job as an excuse!

Retirement today is about freedom of choice

Retirement today does not look like anything in the past. Our families have changed. The economy has changed. Societal norms and expectations have changed.

The old model of stop working at age 65, move somewhere warm, and pursue a life of leisure with a bunch of fellow retirees applies but to a minority.


You can see change all around us, but the biggest change that we often don’t talk about is internal. Our expectations for what we want out of life are different from previous generations.


Retirement today is a la carte. You can't rely on outdated models or a cookie cutter approach to retirement. It's up to you to figure out what you want and how to make it happen.


Have you figured out what you want out of your next phase in life? 

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Thought of the Week – March 8

“What got you here won't get you there.”

- Marshall Goldsmith -


Lesson

  • You always need to be evolving and improving 
  • Don't assume that there won't be another peak once you climb the first mountain 

Action

  • Figure out what you need to do to move closer to your goal
  • Become the person that belongs where you want to go

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Thanks for reading!

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