The ABCs of Behavioral Bias: H-O

There are so many investment-impacting behavioral biases, we could probably identify at least one for nearly every letter in the alphabet. Today, we’ll continue with the most significant ones by looking at: hindsight, loss aversion, mental accounting and outcome bias.

 

Hindsight

 

What is it? In “Thinking, Fast and Slow,” Daniel Kahneman credits Baruch Fischhoff for demonstrating hindsight bias – the “I knew it all along” effect – when he was still a student. Kahneman describes hindsight bias as a “robust cognitive illusion” that causes us to believe our memory is correct when it is not. For example, say you expected a candidate to lose, but she ended up winning. When asked afterward how strongly you predicted the actual outcome, you’re likely to recall giving it higher odds than you originally did. This seems like something straight out of a science fiction novel, but it really does happen!

 

When is it helpful? Similar to blind spot bias (one of the first biases we covered) hindsight bias helps us assume a more comforting, upbeat outlook in life. As “Why Smart People Make Big Money Mistakes” authors Gary Belsky and Thomas Gilovich describe it, “We humans have developed sneaky habits to look back on ourselves in pride.” Sometimes, this causes no harm, and may even help us move past prior setbacks.

 

When is it harmful? Hindsight bias is hazardous to investors, since your best financial decisions come from realistic assessments of market risks and rewards. As Kahneman explains, hindsight bias “leads observers to assess the quality of a decision not by whether the process was sound but by whether its outcome was good or bad.” If a high-risk investment happens to outperform, but you conveniently forget how risky it truly was, you may load up on too much of it and not be so lucky moving forward. On the flip side, you may too quickly abandon an underperforming holding, deceiving yourself into dismissing it as a bad bet to begin with.

 

Loss Aversion

 

What is it? “Loss aversion” is a fancy way of saying we often fear losing more than we crave winning, which leads to some interesting results when balancing risks and rewards. For example, in “Stumbling on Happiness,” Daniel Gilbert describes: “[M]ost of us would refuse a bet that gives us an 85 percent chance of doubling our life savings and a 15 percent chance of losing it.” Even though the odds favor a big win, imagining that slight chance that you might go broke leads most people to decide it’s just not worth the risk.

 

When is it helpful? To cite one illustration of when loss aversion plays in your favor, consider the home and auto insurance you buy every year. It’s unlikely your house will burn to the ground, your car will be stolen, or an act of negligence will cost you your life’s savings in court. But loss aversion reminds us that unlikely does not mean impossible. It still makes good sense to protect against worst-case scenarios when we know the recovery would be very painful indeed.

 

When is it harmful? One way loss aversion plays against you is if you decide to sit in cash or bonds during bear markets – or even when all is well, but a correction feels overdue. The evidence demonstrates that you are expected to end up with higher long-term returns by at least staying put, if not bulking up on stocks when they are “cheap.” And yet, the potential for future loss can frighten us into abandoning our carefully planned course toward the likelihood of long-term returns.

 

Mental Accounting

 

What is it? If you’ve ever treated one dollar differently from another when assessing its worth, that’s mental accounting at play. For example, if you assume inherited money must be more responsibly managed than money you’ve won in a raffle, you’re engaging in mental accounting.

 

When is it helpful? In his early paper, “Mental Accounting Matters,” Richard Thaler (who is credited for having coined the term), describes how people use mental accounting “to keep trace of where their money is going, and to keep spending under control.” For example, say you set aside $250/month for a fun family outing. This does not actually obligate you to spend the money as planned or to stick to your budget. But by effectively assigning this function to that money, you’re better positioned to enjoy your leisure time, without overdoing it.

 

When is it harmful? While mental accounting can foster good saving and spending habits, it plays against you if you instead let it undermine your rational investing. Say, for example, you’re emotionally attached to a stock you inherited from a beloved aunt. You may be unwilling to unload it, even if reason dictates that you should. You’ve just mentally accounted your aunt’s bequest into a place that detracts from rather than contributes to your best financial interests.

 

Outcome Bias

 

What is it? Sometimes, good or bad outcomes are the result of good or bad decisions; other times (such as when you try to forecast future market movements), it’s just random luck. Outcome bias is when you mistake that luck as skill.

 

When is it helpful? This may be one bias that is never really helpful in the long run. If you’ve just experienced good or bad luck rather than made a smart or dumb decision, when wouldn’t you want to know the difference, so you can live and learn?

 

When is it harmful? As Kahneman describes in “Thinking, Fast and Slow,” outcome bias “makes it almost impossible to evaluate a decision properly – in terms of the beliefs that were reasonable when the decision was made.” It causes us to be overly critical of sound decisions if the results happen to disappoint. Conversely, it generates a “halo effect,” assigning undeserved credit “to irresponsible risk seekers …who took a crazy gamble and won.” In short, especially when it’s paired with hindsight bias, this is dangerous stuff in largely efficient markets. The more an individual happens to come out ahead on lucky bets, the more they may mistakenly believe there’s more than just luck at play.

 

We’ve got more behavioral biases to cover in upcoming installments, so stay tuned. Next, we’ll continue through the alphabet, introducing a few more of the most suspect financial behavioral biases.

To read about Behavioral Biases A-F click here

To read about Behavioral Biases F-H click here

 

The Uncommon Average

The US stock market has delivered an average annual return of around 10% since 1926.  But short-term results may vary, and in any given period stock returns can be positive, negative, or flat. When setting expectations, it’s helpful to see the range of outcomes experienced by investors historically. For example, how often have the stock market’s annual returns actually aligned with its long-term average?

Exhibit 1 shows calendar year returns for the S&P 500 Index since 1926. The shaded band marks the historical average of 10%, plus or minus 2 percentage points. The S&P 500 Index had a return within this range in only six of the past 93 calendar years. In most years, the index’s return was outside of the range—often above or below by a wide margin—with no obvious pattern. For investors, the data highlight the importance of looking beyond average returns and being aware of the range of potential outcomes.

 

TUNING IN TO DIFFERENT FREQUENCIES

Despite the year-to-year volatility, investors can potentially increase their chances of having a positive outcome by maintaining a long-term focus. Exhibit 2 documents the historical frequency of positive returns over rolling periods of one, five, and 10 years in the US market. The data show that, while positive performance is never assured, investors’ odds improve over longer time horizons.

Conclusion

While some investors might find it easy to stay the course in years with above average returns, periods of disappointing results may test an investor’s faith in equity markets. Being aware of the range of potential outcomes can help investors remain disciplined, which in the long term can increase the odds of a successful investment experience. What can help investors endure the ups and downs? While there is no silver bullet, understanding how markets work and trusting market prices are good starting points. An asset allocation that aligns with personal risk tolerances and investment goals is also valuable. By thoughtfully considering these and other issues, investors may be better prepared to stay focused on their long-term goals during different market environments.

 

To review our most recent market review for the 2nd Quarter 2019, Click Here 

 

Déjà Vu All Over Again

Investment fads are nothing new. When selecting strategies for their portfolios, investors are often tempted to seek out the latest and greatest investment opportunities.

Over the years, these approaches have sought to capitalize on developments such as the perceived relative strength of particular geographic regions, technological changes in the economy, or the popularity of different natural resources. But long-term investors should be aware that letting short-term trends influence their investment approach may be counterproductive. As Nobel laureate Eugene Fama said, “There’s one robust new idea in finance that has investment implications maybe every 10 or 15 years, but there’s a marketing idea every week.”

WHAT’S HOT BECOMES WHAT’S NOT

Looking back at some investment fads over recent decades can illustrate how often trendy investment themes come and go.

  • In the 1950s, the “Nifty Fifty” were all the rage.
  • In the 1960s, “go-go” stocks and funds piqued investor interest.
  • Later in the 20th century, growing belief in the emergence of a “new economy” led to the creation of funds poised to make the most of the rising importance of information technology and telecommunication services.
  • Early 1990’s: attention turned to the rising “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan. A decade later, much was written about the emergence of the “BRIC” countries of Brazil, Russia, India, and China and their new place in global markets. Similarly, funds targeting hot industries or trends have come into and fallen out of vogue.
  • During the 2000s, 130/30 funds, which used leverage to sell short certain stocks while going long others, became increasingly popular.
  • In the wake of the 2008 financial crisis, “Black Swan” funds, “tail-risk-hedging” strategies, and “liquid alternatives” abounded. As investors reached for yield in a low interest-rate environment in the following years, other funds sprang up that claimed to offer increased income generation, and new strategies like unconstrained bond funds proliferated.
  • More recently, strategies focused on peer-to-peer lending, cryptocurrencies, and even cannabis cultivation and private space exploration have become more fashionable. In this environment, so-called “FAANG” stocks and concentrated exchange-traded funds with catchy ticker symbols have also garnered attention among investors.

THE FUND GRAVEYARD

Unsurprisingly, however, numerous funds across the investment landscape were launched over the years only to subsequently close and fade from investor memory. While economic, demographic, technological, and environmental trends shape the world we live in, public markets aggregate a vast amount of dispersed information and drive it into security prices. Any individual trying to outguess the market by constantly trading in and out of what’s hot is competing against the extraordinary collective wisdom of millions of buyers and sellers around the world.

With the benefit of hindsight, it is easy to point out the fortune one could have amassed by making the right call on a specific industry, region, or individual security over a specific period. While these anecdotes can be entertaining, there is a wealth of compelling evidence that highlights the futility of attempting to identify mispricing in advance and profit from it.

It is important to remember that many investing fads, and indeed, most mutual funds, do not stand the test of time. A large proportion of funds fail to survive over the longer term. Of the 1,622 fixed income mutual funds in existence at the beginning of 2004, only 55% still existed at the end of 2018. Similarly, among equity mutual funds, only 51% of the 2,786 funds available to US-based investors at the beginning of 2004 endured.

 

WHAT AM I REALLY GETTING?

When confronted with choices about whether to add additional types of assets or strategies to a portfolio, it may be helpful to ask the following questions:

  1. What is this strategy claiming to provide that is not already in my portfolio?
  2. If it is not in my portfolio, can I reasonably expect that including it or focusing on it will increase expected returns, reduce expected volatility, or help me achieve my investment goal?
  3. Am I comfortable with the range of potential outcomes?

If investors are left with doubts after asking any of these questions, it may be wise to use caution before proceeding. Within equities, for example, a market portfolio offers the benefit of exposure to thousands of companies doing business around the world and broad diversification across industries, sectors, and countries. While there can be good reasons to deviate from a market portfolio, investors should understand the potential benefits and risks of
doing so.

In addition, there is no shortage of things investors can do to help contribute to a better investment experience. Working closely with a financial advisor can help individual investors create a plan that fits their needs and risk tolerance. Pursuing a globally diversified approach; managing expenses, turnover, and taxes; and staying disciplined through market volatility can help improve investors’ chances of achieving their long-term financial goals.

 

CONCLUSION

Fashionable investment approaches will come and go, but investors should remember that a long-term, disciplined investment approach based on robust research and implementation may be the most reliable path to success in the global capital markets.

Keep this in mind as you reflect on the past 12 months in the markets (shown below).

 

What Does 2018 Mean

What does 2018 mean to us…

Part One: General Principles

We neither forecast the economy, nor attempt to time the markets, nor predict which market sectors will “outperform” which others over the next block of time. In a sentence that always bears repeating: We are planners rather than a prognosticators.

Once a client family has a plan in place—and has funded it with what have historically been the most appropriate types of investments—we will hardly ever recommend changing the portfolio so long as your long-term goals haven’t changed.  As a general statement, we have found that the more often investors change their portfolios (in response to the market fears or fads of the moment), the worse their long-term results.

In sum, our essential principles of portfolio management are fourfold.

  • (1) The performance of a portfolio relative to a benchmark is largely irrelevant to long-term financial success.
  • (2) The only benchmark we should care about is the one that indicates whether you are on track to accomplish your financial goals.
  • (3) Risk should be measured as the probability that you won’t achieve your goals.
  • (4) Investing should have the exclusive objective of minimizing that risk.

Part Two: Current Observations

2018 was perhaps the strangest year we have experienced in our careers as financial advisors. Most importantly, it was one of the truly great years in the history of the American economy, and by far the best one since the global financial crisis of 10 years past. Paradoxically, it was also a year in which the equity market could not get out of its own way.

It is almost impossible to cite all the major metrics of the economy which blazed ahead in 2018. Worker productivity, which is the long-run key to economic growth and a higher standard of living, surged. Wage growth accelerated in response to a rapidly falling unemployment rate. Household net worth rose above $100 trillion for the first time, yet household debt relative to net worth remained historically low. Finally—and to me this sums up the entire remarkable year—for the first time in American history, the number of open job listings exceeded the number of people seeking employment.

Earnings of the S&P 500 companies, paced by robust GDP growth and significant corporate tax reform, leaped upward by more than 20%. Cash dividends set a new record; indeed total cash returned to shareholders from dividends and share repurchases since the trough of the Great Panic reached $7 trillion.

But the equity market had other things on its mind. Having gone straight up without a correction throughout 2017, the S&P 500 came roaring into 2018 at 2,674—probably somewhat ahead of itself, as it seemed to be discounting the entire future effect of corporate tax cuts in one gulp. There ensued in February a 10% correction, followed by several months of consolidation. The advance resumed as summer waned, with the Index reaching a new all-time high of 2,931 in late September. It then gave way to a second correction.

The major economic and market imponderable as the year turns is trade policy, which in the larger sense is an inquiry into the mind of President Trump. It is fair to say, as the economist Scott Grannis recently did, that “Trump has managed to reduce tax and regulatory burdens in impressive fashion, but his tweets and his tariff threats have created unnecessary distractions and unfortunate uncertainties, not to mention higher prices for an array of imported consumer goods.”

These and other uncertainties—perhaps chief among them Fed policy and an aging expansion—were weighing heavily on investor psychology as the year drew to a close. For whatever it may be worth, our experience has been that negative investor sentiment—and the resulting equity price weakness—have usually presented the patient, disciplined long-term investor with enhanced opportunity. As the wise and witty Sage of Omaha wrote in his 1994 shareholder letter, “Fear is the foe of the faddist, but the friend of the fundamentalist.”

Part Three: Looking Forward

What is good about all of this?

Interest rates and mortgage rates remain relatively low, with energy prices trending down. All of these are good, both for businesses and consumers.

Volatility can be hard to experience, but it indicates a normal, functioning market. It also correlates strongly with expected returns. Where there is no volatility, there is also no return (consider a bank account). A carefully measured amount should be embraced.

What can you be doing?

First, keep your faith in the future. We urge you to read the 2018 Market Review as an antidote to any messages you may have heard or will hear in the months ahead.

2018 Market Review

 

Second, maintain your proactive behavior and discipline.

  • If you’ve committed to a saving plan, or to an IRA funding plan, keep at it. If not, now is the time to begin. Lower stock prices are good entry points; as the broad market falls, value rises. We don’t know when this decline (read: sale) will end, only that it WILL end.

 

  • If you’ve committed to a withdrawal plan, know that your portfolio is managed to reliably provide income regardless of market conditions. Most portfolios have nearly one decade of reserves before an extended market event would suggest consideration.

Without committing additional funds, you may still benefit from lower asset prices by converting some or all of an IRA to a Roth IRA. This action pays the government’s inevitable tax bill at a time when asset prices are lower, and so therefore is the tax bill. Furthermore, federal income tax brackets are historically low. Action guarantees a known tax rate today against an unknown future tax rate.

What are we doing?

Even if you do not act on the items previously mentioned, we are considering them for you. It helps us greatly in this regard to see your most current tax return and for you to promptly notify us if your income is expected to markedly rise or fall as compared to previous years.

In addition, we’ve spent much of the last few months capturing the opportunities this period presented. By harvesting available positions within taxable accounts we’ve created what amounts to a “coupon” against future tax liabilities to offset future gains and potentially, earned income.

Current volatility has also allowed us to rebalance most accounts in a classic exercise of buying low to sell high. Amongst the assets classes, and overall, we have largely been able to do so without triggering a tax bill. Even without the addition of new funds, the purpose-built stability of the income/bond side of your portfolio allowed the reinvestment of dividends, interest, and capital gains at lower entry points. This was a fleeting opportunity created by lower asset prices.

Through this period, we have been net buyers of the greatest businesses in the US and the World. Tomorrow may show this timing premature. Yet, we accept this uncertainty in the shorter-term in exchange for more certainty over time.

Where do we go from here?

Going forward, the only question that matters is the one we guard against the most: Will you outlive your money? If this concern resonates with you, our approach has been designed to minimize that risk.

If you are confident that you have enough, then the only question that matters is: Are you making the best and most intentional decisions to live your life as rewarding and as richly as possible? This is a much more difficult and involved answer. Working towards these answers with you is one of the main reasons we look forward to coming in each day.

We’re sure to have forgotten something or created other questions for you in this message. That’s okay for now; this is all a process and an ongoing conversation. Some questions are easily answered by email or phone, but some are not and require a discussion of options, research, or a face-to-face conversation. Everyone’s situation is a little different.

 

Please, let us know what is on your mind.

 

The ABCs of Behavioral Bias: F-H

Let’s continue our alphabetic tour of common behavioral biases (See A-F here) that distract otherwise rational investors from making best choices about their wealth. Today, we’ll tackle F-H: fear, framing, greed and herd mentality.

 

Fear

 

What is it? You know what fear is, but it may be less obvious how it works. As Jason Zweig describes in “Your Money & Your Brain,” if your brain perceives a threat, it spews chemicals like corticosterone that “flood your body with fear signals before you are consciously aware of being afraid.” Some suggest this isn’t really “fear,” since you don’t have time to think before you act. Call it what you will, this bias can heavily influence your next moves – for better or worse.

 

When is it helpful? Of course there are times you probably should be afraid, with no time for studious reflection about a life-saving act. If you are reading this today, it strongly suggests you and your ancestors have made good use of these sorts of survival instincts many times over.

 

When is it harmful? Zweig and others have described how our brain reacts to a plummeting market in the same way it responds to a physical threat like a rattlesnake. While you may be well-served to leap before you look at a snake, doing the same with your investments can bite you. Also, our financial fears are often misplaced. We tend to overcompensate for more memorable risks (like a flash crash), while ignoring more subtle ones that can be just as harmful or much easier to prevent (like inflation, eroding your spending power over time).

 

Framing

 

What is it? Thinking, Fast and Slow,” Nobel laureate Daniel Kahneman defines the effects of framing as follows: “Different ways of presenting the same information often evoke different emotions.” For example, he explains how consumers tend to prefer cold cuts labeled “90% fat-free” over those labeled “10% fat.” By narrowly framing the information (fat-free = good, fat = bad; never mind the rest), we fail to consider all the facts as a whole.

 

When is it helpful? Have you ever faced an enormous project or goal that left you feeling overwhelmed? Framing helps us take on seemingly insurmountable challenges by focusing on one step at a time until, over time, the job is done. In this context, it can be a helpful assistant.

 

When is it harmful? To achieve your personal financial goals, you’ve got to do more than score isolated victories in the market; you’ve got to “win the war.” As UCLA’s Shlomo Benartzi describes in a Wall Street Journal piece, this demands strategic planning and unified portfolio management, with individual holdings considered within the greater context. Investors who instead succumb to narrow framing often end up falling off-course and incurring unnecessary costs by chasing or fleeing isolated investments.

 

Greed

 

What is it? Like fear, greed requires no formal introduction. In investing, the term usually refers to our tendency to (greedily) chase hot stocks, sectors or markets, hoping to score larger-than-life returns. In doing so, we ignore the oversized risks typically involved as well.

 

When is it helpful? In Oliver Stone’s Oscar-winning “Wall Street,” Gordon Gekko (based on the notorious real-life trader Ivan Boesky) makes a valid point … to a point: “[G]reed, for lack of a better word, is good. … Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind.” In other words, there are times when a little greed – call it ambition – can inspire greater achievements.

 

When is it harmful? In our cut-throat markets (where you’re up against the Boeskys of the world), greed and fear become a two-sided coin that you flip at your own peril. Heads or tails, both are accompanied by chemical responses to stimuli we’re unaware of and have no control over. Overindulging in either extreme leads to unnecessary trading at inopportune times.

 

Herd Mentality

 

What is it? Mooove over, cows. You’ve got nothing on us humans, who instinctively recoil or rush headlong into excitement when we see others doing the same. “[T]he idea that people conform to the behavior of others is among the most accepted principles of psychology,” say Gary Belsky and Thomas Gilovich in “Why Smart People Make Big Money Mistakes.”

 

When is it helpful? If you’ve ever gone to a hot new restaurant, followed a fashion trend, or binged on a hit series, you’ve been influenced by herd mentality. “Mostly such conformity is a good thing, and it’s one of the reasons that societies are able to function,” say Belsky and Gilovich. It helps us create order out of chaos in traffic, legal and governmental systems alike.

 

When is it harmful? Whenever a piece of the market is on a hot run or in a cold plunge, herd mentality intensifies our greedy or fearful chain reaction to the random event that generated the excitement to begin with. Once the dust settles, those who have reacted to the near-term noise are usually the ones who end up overpaying for the “privilege” of chasing or fleeing temporary trends instead of staying the course toward their long-term goals. As Warren Buffett has famously said, “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”

Well said, Mr. Buffett!

 

We’ve got more behavioral biases to cover in upcoming installments, so stay tuned. Next, we’ll continue through the alphabet, introducing a few more of the most suspect financial behavioral biases.

To read about Behavioral Biases A-F click here

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Outcomes = Events + Response

Being an investor can be complicated, challenging, frustrating, and sometimes frightening. This is exactly why it is important to have an investment philosophy you can stick with, one that can help you stay the course, and respond rationally to unexpected events.

This simple idea highlights an important question: How can investors maintain discipline through bull markets, bear markets, political strife, economic instability, or whatever crisis du jour threatens progress towards their investment goals?

Over their lifetimes, investors face many decisions, prompted by events that  are both within and outside their control. Without an enduring philosophy to inform their choices, they can potentially suffer unnecessary anxiety, leading  to poor decisions and outcomes that are damaging to their long-term financial well-being.

When they don’t get the results they want, many investors blame things outside their control. They might point the finger at the government, central banks, markets, or the economy. Unfortunately, the majority will not do the things that might be more beneficial—evaluating and reflecting on their own responses to events and taking responsibility for their decisions.

Some people suggest that among the characteristics that separate highly successful people from the rest of us is a focus on influencing outcomes by controlling one’s reactions to events, rather than the events themselves. This relationship can be described in the following formula:

e + r = o (Event + Response = Outcome)

Simply put, this means an outcome—either positive or negative—is the result of how you respond to an event, not just the result of the event itself. Of course, events are important and influence outcomes, but not exclusively. If this were the case, everyone would have the same outcome regardless of their response.

Let’s think about this concept in a hypothetical investment context. Say a major political surprise, such as Brexit, causes a market to fall (event). In a panicked response, potentially fueled by gloomy media speculation of the resulting uncertainty, an investor sells some or all of his or her investment (response). Lacking a long-term perspective and reacting to the short-term news, our investor misses out on the subsequent market recovery and suffers anxiety about when, or if, to get back in, leading to suboptimal investment returns (outcome).

To see the same hypothetical example from a different perspective, a surprise event causes markets to fall suddenly (e). Based on his or her understanding of the long-term nature of returns and the short-term nature of volatility spikes around news events, an investor is able to control his or her emotions (r) and maintain investment discipline, leading to a higher chance of a successful long‑term outcome (o).

This example reveals why having an investment philosophy is so important. By understanding how markets work and maintaining a long-term perspective on past events, investors can focus on ensuring that their responses to events are consistent with their long-term plan.

An enduring investment philosophy is built on solid principles backed by decades of academic evidence. Examples of such principles might be: trusting that prices are set to provide a fair expected return (markets work); recognizing the difference between investing and speculating (long-term perspective); relying on the power of diversification to manage risk and increase the reliability of outcomes (Diversification); and benchmarking your progress against your own realistic long-term investment goals (monitoring progress).

Combined, these principles might help us react better to market events, even when those events are globally significant or when, as some might suggest, a paradigm shift has occurred, leading to claims that “it’s different this time.” Adhering to these principles can also help investors resist the siren calls of new investment fads or worse, outright scams.

It can be difficult for investors to develop a rational investment philosophy. And even the most self-aware find it hard to manage their own responses to events. Investing will always be both alluring and scary at times, but a view of how to approach investing combined with the guidance of a trusted professional can help people stay the course through challenging times. Keeping an objective view and separating emotions from investment decisions is incredibly difficult for most investors.  By building knowledge and confidence, however, we are better equipped to remain disciplined in our responses even to the most extreme market events.

WCU Class Dates – October 2019 Biltmore Park

Are you prepared for one of the biggest transitions in your life?

 

Tuesday, October 8

Thursday, October 10

 

Classes are 5:30-8:30 PM

We hold our classes at WCU’s new Biltmore Park Campus.  Tuition is $79 per person (or couple) and includes workbooks and other bonus materials.

 

REGISTER THROUGH WCU TODAY!

(Click link above to register for Retirement Planning Today through WCU’s website)

 

Contact Instructors Here

(Click link above to contact instructors with any questions)

 

Course Description:
In partnership with Western Carolina University Office of Professional Growth and Enrichment, we are pleased to offer a Retirement Planning workshop.  This course is designed to deliver comprehensive, objective information to help you achieve your most important financial goals.  The course covers many key aspects of planning for retirement such as:

  • Retirement lifestyle planning
  • Goal Setting
  • Retirement Planning Roadblocks and Mistakes
  • Income tax planning
  • Retirement income and expenses
  • Risk management
  • Social Security Planning
  • Investment management
  • Estate planning

 

The course specifically focuses on the ‘Four Pillars of a Successful Retirement.’

  • Social Security – Deciding carefully when and how to tap Social Security Benefits
  • Income Strategy – Developing an income strategy that covers your everyday expenses and basic needs
  • Tax Planning – Making sure that Uncle Sam doesn’t get more than his fair share
  • Legacy Planning – Planning for your later years and beyond, especially if one of your objectives is to leave a legacy

Retirement is usually seen as life’s reward for working hard, supporting a family, and saving your hard-earned dollars. You celebrate with a big party and then move into this exciting, new life stage.  Is that how you envision it?

In the past, retirement often meant switching from a paycheck to a pension check, contacting Social Security to get benefits in motion, and maybe supplementing that income with the proceeds from downsizing a home or renting a property. 

But time shave changed. Retirement can now mean piecing together a big puzzle, composed of a variety of different resources, to ensure you have enough to live on- and maybe have asomething left to pass on to heirs if that’s one of your goals.

Instructors: Joel Kelley, CFP® and Jacob Sadler, CFP®

 

 

Do you have the time..

desire…

and most important, the knowledge…

to build a financial strategy for retirement?

Having a Plan

In our most recent Market Review, for the 1st Quarter 2018 we provide a general report and perspective on global market activity. 

1st Quarter 2018 Market Review

 

Embarking on a financial plan is like sailing around the world. The voyage won’t always go to plan, and there’ll be rough seas.  But the odds of reaching your destination increase greatly if you are prepared, flexible, patient, and well-advised.

A mistake many inexperienced sailors make is not having a plan at all.  They embark without a clear sense of their destination. And once they do decide, they often find themselves lost at sea in the wrong boat with inadequate provisions.

Likewise, in planning an investment journey, you need to decide on your goal. A first step might be to consider whether the goal is realistic and achievable. For instance, while you may long to retire in the south of France, you may not be prepared to sacrifice your needs today to satisfy that distant desire.

Once you are set on a realistic destination, you need to ensure you have the right portfolio to get you there. Have you planned for multiple contingencies? What degree of “bad weather” can your plan withstand along the way?

Key to a successful voyage is a good navigator. A trusted advisor is like that, regularly taking coordinates and making adjustments, if necessary. If your circumstances change, the advisor may suggest you replot your course.

As with the weather at sea, markets can be unpredictable. A sudden squall can whip up waves of volatility, tides can shift, and strong currents can threaten to blow you off course. Like a seasoned sailor, an experienced advisor will work with the conditions.

Once the storm passes, you can pick up speed again. Just as a sturdy vessel will help you withstand most conditions at sea, a well-diversified portfolio can act as a bulwark against the sometimes tempestuous conditions in markets.

Circumnavigating the globe is not exciting every day. Patience is required with local customs and paperwork as you pull into different ports. Likewise, a lack of attention to costs and taxes is the enemy of many a long-term financial plan.

Distractions can also send investors, like sailors, off course. In the face of “hot” investment trends, it takes discipline not to veer from your chosen plan. Like the sirens of Greek mythology, media pundits can also be diverting, tempting you to change tack and act on news that is already priced in to markets.

A lack of flexibility is another impediment to a successful investment journey.  If it doesn’t look as though you’ll make your destination in time, you may have to extend your voyage, take a different route to get there, or even moderate your goal.

The important point is that you become comfortable with the idea that uncertainty is inherent to the investment journey, just as it is with any sea voyage. That is why preparation and planning are so critical. While you can’t control every outcome, you can be prepared for the range of possibilities and understand that you have clear choices if things don’t go according to plan.

If you can’t live with the volatility, you can change your plan. If the goal looks unachievable, you can lower your sights. If it doesn’t look as if you’ll arrive on time, you can extend your journey.

Of course, not everyone’s journey is the same. Neither is everyone’s destination. We take different routes to different places, and we meet a range of challenges and opportunities along the way.

But for all of us, it’s critical that we are prepared for our journeys in the right vessel, keep our destinations in mind, stick with the plans, and have a trusted navigator to chart our courses and keep us on target.

 

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services: 828.225.1730

What is a CCRC?

Today a growing number of Americans are faced with a complex set of personal and financial decisions about how and where they want to live as they age.  An important factor in these decisions is how to address the significant risk posed by long term care expenses.  The three most common strategies to allow most people to manage the issue of long term care and aging are:

  1. Use all your assets – For some, there are few affordable options, and they rely on either family support or Medicaid to provide their long term care. Medicaid is the government provided ‘safety net’ form of health insurance and long term care protection. Eligibility for Medicaid requires that you have very little or no ‘countable assets’ and your sources of income will be scrutinized as well.  While a spouse who does not need long term care may retain some income and assets for their own use, relying on Medicaid may either require specific planning (well in advance) or spending down nearly all of your assets before it becomes available.
  2. Protect assets with insurance – For others, purchasing long term care insurance (or hybrid long term care insurance) to manage the risk of long term care expenses is an appealing strategy – particularly for those who wish to stay in their homes as long as possible. According to a survey conducted by AARP, 90% of people age 65 or older want to ‘age in place’ (in their home). However, the reality is that this strategy can quickly become impractical, dangerous, and isolating over time.  For those that plan to age in place, long term care insurance can become a critical piece of their financial picture. The key is to plan in advance, because premiums can be expensive, and will likely increase over time.  It is also important to keep in mind that not everyone will qualify for long term care insurance, and to make sure that you meet the health requirements for a long term care insurance policy.
  3. Have more than enough assets – For those who have a ‘critical mass’ of assets, it is possible to pay out of pocket for long term care expenses without jeopardizing the standard of living for a spouse, or compromising other financial objectives. While there is no one size fits all ‘number’ at which point you would pay out of pocket, generally investable assets of $2 Million or more, and a high ratio of guaranteed sources of income to living expenses are needed to consider this option.

There is a fourth strategy however, that for many individuals or couples can provide answers to many of these questions all at once.

  1. Live where you get your care – For those who want a single solution to meet their personal and financial situation in retirement, a Continuing Care Retirement Community (CCRC) can provide an appropriate solution to manage long term care treatment and expenses, while providing a living arrangement based on their level of independence and activity. So – what exactly is a CCRC and how do you evaluate it. We will analyze this question in different articles within our ‘classroom’ over time.  For now let’s start with:  What is a CCRC?

A CCRC is an age-restricted community that offers a continuum of care and living arrangements all on the same campus. Typically new residents must be age 65 or older; and living arrangements range from independent-living units, to assisted-living units, and then to skilled-nursing facilities.

These communities attract seniors who desire to live independently initially, but also want to know that they can receive needed care without leaving the community. This arrangement allows the resident to stay close to their spouse and friends as they move through different levels of care – and you know in advance about the quality, the options, and the location of the care you will receive.

CCRC’s often require a large entrance fee up front, but these vary widely depending on the community ($50,000-$1,000,000+).  In addition, residents pay a monthly fee.  Typically, the entrance fee may be returned in whole or in part when the resident leaves the CCRC, and another resident is found to occupy the unit. Once the new resident pays the entrance fee the former resident (or his or her estate) receives a refund. In exchange for the entrance fee, residents of the CCRC gain access to the community and the various levels of care, i.e. assisted living and skilled-nursing facilities.

As residents move from independent living to different levels of care, the monthly fee may increase – but not always (this also depends on the community). Typically, the larger the entrance fee, the lower the increase in monthly expenses for higher levels of care. Whether the monthly fee increases or not, residents generally pay less than the full-market rate for the care that they receive.  This fee structure, allows the resident to shift some of risk of long term care expenses to the community. Residents who do need care are essentially subsidized by residents who never need care. As a result CCRCs usually require prospective residents to submit financial and health information before they are admitted, and like purchasing insurance, it is better to plan this decision before a disqualifying health condition arises such as Alzheimer’s. It is possible for an applicant to be denied admittance due to health issues.

Also similar to a traditional insurance policy, the ability of the facility to provide care when needed depends on its financial stability, and its ‘claims’. If a higher than expected number of residents needs care, the facility may run into financial difficulty.  As a result, it is important to assess the financial strength of a community before entering.

CCRCs are also concerned that residents will run out of money and no longer be able to afford the monthly fee. To avoid the possibility that residents may become financially unable to stay in the community, facilities require prospective residents to submit financial information. An applicant may be denied admittance if the facility believes their assets and income will be depleted before death. While some communities establish reserves that are available to residents who can no longer afford to pay the monthly fee, this is not guaranteed and some communities may not have funds available.

CCRC Planning

If a CCRC is an option that you are considering as a part of your retirement plan, it is essential to develop a plan. The planning process allows you to decide on a retirement arrangement that is best suited to your needs – whether it is a CCRC or not.  Without planning, the questions, complexity, time, and analysis that are required can be overwhelming – and many people may either avoid making a decision all together, or make a less than informed decision that doesn’t fit with their situation.  For those who feel that a CCRC can provide a dependable living arrangement in retirement, and that want to explore the pros and cons of a CCRC – start the planning process sooner rather than later.

 

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services, including retirement planning and CCRC planning.

 

Rebalancing: The How, When, and Why

If there is a universal investment ideal, it is this: Every investor wants to buy low and sell high.

What if we told you there is a disciplined process for doing just that, and staying on track toward your personal goals while you’re at it? Guess what…There is. It’s called rebalancing.

 

Rebalancing: How It Works

Imagine it’s the first day of your investment experience. As you create your new portfolio, it’s best if you do so according to a personalized plan that prescribes how much weight you want to give to each asset class. So much to stocks, so much to bonds … and so on. Assigning these weights is called asset allocation.

Then time passes. As the markets shift around, your investments stray from their original allocations. That means you’re no longer invested according to plan, even if you’ve done nothing at all; you’re now taking on higher or lower market risks and expected rewards than you originally intended. Unless your plans have changed, your portfolio needs some attention.

 

But Why rebalance?

At first glance, rebalancing seems counter-productive. Why sell a portion of outperforming asset groups and acquire a larger share of underperforming ones? Intuition might suggest that selling previous winners may hinder returns in the future. This logic is flawed, however, since past performance may not continue in the future and there’s no reliable way to predict future returns.

Equally important, remember that you chose your original asset allocation to reflect your risk and return preferences. Rebalancing realigns your portfolio to these priorities by using structure, not recent performance, to drive investment decisions. Periodic rebalancing also encourages dispassionate decision making an essential quality during times of market volatility. Moreover, if and when your overall financial goals or risk tolerance change, you have a foundation for making adjustments. In the absence of a plan, adjustments are a matter of guesswork. This is what rebalancing is for: to shift your assets back to their intended, long-term allocations – systematically buying low and selling high.

 

Portfolio Balancing: A Closer Look

We’ve now shared a simple rebalancing illustration. In reality, rebalancing is more complicated, because asset allocation is completed on several levels. First, we suggest balancing your stocks versus bonds, reflecting your need to take on market risk in exchange for expected returns. Then we typically divide these assets among stock and bond subcategories, again according to your unique financial goals. For example, you can assign percentages of your stocks to small- vs. large-company and value vs. growth firms, and further divide these among international, U.S., and/or emerging markets.

 One reason for these relatively precise allocations is to maximize your exposure to the right amount of expected market premiums for your personal goals, while minimizing the market risks involved by diversifying those risks around the globe and across sources of returns that don’t always move in tandem with one another. We, and the fund managers we typically turn to for building our portfolios are guided by these tenets of evidence-based investing.

It’s scary to do in real time. Everyone understands the logic of buying low and selling high. But when it’s time to rebalance, your emotions make it easier said than done. To illustrate, consider these real-life scenarios.

 

When markets are down:

Bad times in the market can represent good times for rebalancing. But that means you must sell some of your assets that have been doing okay and buy the unpopular ones. The Great Recession of 2007–2009 is a good example. To rebalance then, you had to sell some of your safe-harbor holdings and buy stocks, even as popular opinion was screaming that stocks were dead. Of course history has shown otherwise; those who did rebalance were best positioned to capture available returns during the subsequent recovery. But at the time, it represented a huge leap of faith in the academic evidence indicating that our capital markets would probably prevail.
 

Those who did rebalance were best positioned to capture available returns during the subsequent recovery.

 

When markets are up:

An exuberant market can be another rebalancing opportunity – and another challenge – as you must sell some of your high flyers (selling high) and rebalance into the lonesome losers (buying low). At the time, this can feel counterintuitive. But disciplined rebalancing offers a rational approach to securing some of your past gains, managing your future risk exposure, and remaining invested as planned, for capturing future expected gains over the long-run.

 

The Rebalancing Take-Home

Rebalancing using evidence-based investment strategies makes a great deal of sense once you understand the basics. It offers objective guidelines and a clear process to help you remain on course toward your personal goals in rocky markets. It ensures you are buying low and selling high along the way. What’s not to like about that?

At the same time, rebalancing your globally diversified portfolio requires informed management, to ensure it’s being integrated consistently and cost effectively. An objective advisor also can help prevent your emotions from interfering with your reason as you implement a rebalancing plan. Helping clients periodically employ efficient portfolio rebalancing is another way [firm name] seeks to add value to the investment experience

In an uncertain world, investors should have a well-defined, globally diversified strategy and manage their portfolio to implement it over time. Rebalancing is a crucial tool in this effort

No one knows where the capital markets will go and that’s the point.

 

 

 

In our most recent Market Review, for the 4th Quarter 2017 we provide a general report and perspective on global market activity during the most recent quarter and for the full year 2017. 

4th Quarter and Full Year 2017 Market Review

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services