I’ve been holding free workshops for investors for more than 20 years, and they’ve helped thousands of investors achieve higher returns and greater peace of mind while avoiding (or in some cases minimizing) the worst mistakes that so many people make.
In the fall of 2004 I launched a brand new workshop called “Investing After 50.”
I’ve been holding free workshops for investors for more than 20 years, and they’ve helped thousands of investors achieve higher returns and greater peace of mind while avoiding (or in some cases minimizing) the worst mistakes that so many people make.
In the fall of 2004 I launched a brand new workshop called “Investing After 50.”
The whole point is to motivate and help investors to take better care of themselves. I have spent a lot of time thinking and reading about why investors don’t do better than they do, and my workshop will reflect what I’ve learned.
Unfortunately, many investors fall into patterns of making poor decisions. They take shortcuts and rely on their emotions and intuition instead of on knowledge, analysis and thought.
Experts in behavioral finance, the study of how and why people make financial decisions, have concluded that investors’ returns are hugely influenced by individual behavior.
From 1984 through 2002, the Standard & Poor’s 500 Index had an annualized return of 12.2 percent. In that same period, according to a widely reported study by Dalbar, a financial research company based in Boston, the average U.S. equity mutual fund investor achieved an annualized return of only 3.5 percent.
Why the huge difference? Individual decisions about when to be in the market and when to be on the sidelines. Timing, in other words.
This was not market timing based on a system or a discipline. It was timing based on individual judgments, predictions and emotions such as fear and greed, hope and hopelessness.
Many investors committed their money for the first time in the late 1990s (greed) only to get clobbered by three years of a severe bear market. Many of them finally fled the market in 2001 or 2002 (fear) and stayed on the sidelines until well after the start of the strong recovery in 2003.
There’s a huge body of research showing that, by and large, more knowledgeable investors make more productive decisions. On the other hand, investors who are relatively uninformed tend to be overconfident in their ability to predict short-term market trends and to sort out which events really matter and which don’t.
None of that is any surprise to those who closely observe the behavior of investors. In fact, Madison Avenue and Wall Street have effectively teamed up to exploit these facts in a very organized (and usually legal) way.
My new workshop is designed to arm investors with the knowledge that will help them recognize and resist these powerful forces that have combined to take advantage of investor psychology.
We’ll talk in the workshop about fraud, which I think can be described as any form of intentional deception or misrepresentation by which one person attempts to gain an advantage over another.
By that definition, the investment industry is fraught with fraud. My workshop attempts to uncover this fraud and show investors how they can protect themselves from it.
I’ve been studying what’s known as heuristic thinking (something you can look up in a Google online search) and how it leads investors astray by relying on mental shortcuts. One popular mental shortcut is the herd mentality. When “everybody” is doing something, people don’t want to be left behind.
(American natives used to take advantage of this by chasing frightened buffaloes over steep cliffs where they could be easily slaughtered after breaking their legs and often their backs. Clothing designers and manufacturers take advantage of this today, doing their best to create ever-changing fashions that will prompt people to ditch perfectly good clothing merely for the sake of something new.)
People often get in trouble because they are too eager for easy answers to complex questions. The resulting answers may be easy, but they are seldom the best answers. (An excellent example is the proliferation of “lifestyle” mutual funds that purport to give investors everything they need in a single package based only on an investor’s expected retirement date.)
A popular “common sense” mental shortcut tells us that expensive items are of better quality than inexpensive ones. Common variations of this shortcut are known as “You get what you pay for” and “There’s no free lunch.”
In many cases those statements are true. But not always. “You get what you pay for” is an argument that’s been used for decades by brokers to keep people from buying low-cost index funds. Investors who buy that argument wind up paying unnecessarily high expenses for funds that are likely to do worse than index funds.
Another example of a rule of thumb: The more experts who recommend something, the better it must be. If this were true, shareholders in Janus funds (the most-recommended funds by investment advisors and in the press in the late 1990s) would have made out like bandits during the bear market. Instead, many investors lost big chunks of their life savings in the highly touted Janus funds. Worse, almost all the best managers at Janus left.
If you believe you’re a rigorous thinker, take the following simple quiz:
I’m going to describe a woman named Mary, who is quiet, studious and very concerned with social issues. As an undergraduate at Berkeley, she majored in English literature and outdoor studies.
Which of the following statements is most likely to be true:
A. Mary is a librarian.
B. Mary is a librarian and a member of the Sierra Club.
C. Mary works in the banking industry.
Most people would choose B, and they would be dead wrong.
Why? The question does not ask us about Mary as an individual. The question is purely about probabilities. First, there are probably at least 10 people in the banking industry in this country for every librarian, so right away you know there’s a higher probability that she’s in the banking business than a librarian. That makes “C” the correct answer.
Second, if our only two choices were “A” and “B,” the right answer would have to be “A.” Why? Because it’s almost certain that only a minority of librarians are members of the Sierra Club. That makes “B” the least probable answer instead of the most probable one.
You may think that is a “trick question,” and in some ways it is. But it’s typical of the leaps of reasoning that we are asked to take all the time by companies that want our business. If an add for a brokerage firm shows two people who look happy, does that mean you would be happy doing business there? Does it mean the majority of that company’s clients are happy? Hardly!
Now try this: Imagine I show you two closed boxes, each of which has a button on the top and an opening through which a single tennis ball will pop out when the button is pushed. I’m going to pay you to push the button on one of those boxes, and you have to choose the box. If a red ball pops out of the box, I’ll pay you $100. If it’s a white ball, you’ll get only a dime.
(To help you think about this, the question is really which box will give you the higher expected return. And in this case, that means which has a higher probability of producing a red ball from a single push of the button.)
Here’s additional information I’ll give you before you make your choice: Box A contains one red ball and nine white balls. Box B contains seven red balls and 93 white ones. I shake the boxes up to make sure the contents are jumbled at random and then ask you to make your choice.
Which box would you pick? People confronted with this question in research tend to choose Box B, explaining that it has seven chances to pay off instead of only one chance. However, the big payoff is more likely from Box A. Mathematically, the probabilities of getting a red ball are 10 percent in Box A and 7 percent in Box B.
The odds are that you answered the first question incorrectly and, after thinking more carefully, answered the second question correctly. This is exactly the learning process I hope to impart in my workshop. I want people to stop and think before they make decisions that can cost them money.
Thinking via shortcuts leads investors down all sorts of dead-end paths. Recent events take on huge “meaning” even though they are likely to be nothing but random blips. Repetition of a message, regardless of the content, makes it more believable. The emotional impact of visual imagery (think of the cowboy on horseback in the Marlboro ad) overwhelms well documented factual information (think of the surgeon general’s warning).
As you would expect, the heart of my workshop is dedicated to showing investors how to put together the best possible portfolio. I’ll share the latest information on small-cap funds, value funds and international funds.
For example, I have new details to present about investing in emerging markets. I’ll show how you can use three emerging markets index funds to boost the annualized rate of return of this asset class from 14.8 percent to 18.8 percent while reducing risks.
Another expanded topic is retirement withdrawals.
I’ve observed over the years that most retirees pay too little attention to choosing a strategy for drawing money out of their portfolios. It can be tempting, after a lifetime of working and saving, to pay yourself whatever retirement “salary” will make you happy.
But unless you have a ton of money or you know you don’t have long to live, that can be a big mistake.
When you retire, you must make some vital choices that will determine your financial future. Two of the most important questions are these:
· How much will I take out of my portfolio each year?
· Do I need a known, fixed income adjusted for inflation, or can I meet my needs with a variable income that fluctuates year by year depending on how my investments perform?
To give this topic more prominence, I’ve added some new distribution strategies to consider.
The distribution tables that follow are based on actual market returns from 1970 through 2003 assuming various distribution plans for an investor with a $1 million portfolio allocated 60 percent in global equities and 40 percent in fixed-income funds.
In Table 1, you’ll see year-by-year results of two withdrawal strategies that provide a predictable, growing income to the investor. The aggressive plan starts with a distribution of 8 percent ($80,000), and the conservative plan starts with 6 percent ($60,000).
In each case, the distribution increases by 3.5 percent every year to cover presumed inflation. This increase takes place no matter what happens to the returns of the portfolio. This provides the investor with a known future income and the ability to plan accordingly.
The aggressive schedule pays out more money and leaves less at the end. In the first 15 years, perhaps covering a retirement from age 60 through 75, total distributions were $1,543,654 in the aggressive schedule, while the conservative schedule produced $1,157,741 total withdrawals.
The big difference was in the 2003 year-end balances: $2.2 million left in the aggressive portfolio vs. $16.2 million in the conservative one.
Table 2 is similar except that the distributions are variable, depending on portfolio performance. The aggressive schedule pays out 8 percent of the prior-year ending portfolio balance; the conservative schedule pays out only 6 percent.
This variable plan has obvious benefits. It lets a retiree reap the rewards of good stock market performance while it prescribes a dose of moderation during bad times. It does both of these things automatically, without the need for economic forecasts or guessing the future.
However, when you are going to vary your withdrawals this way, you face a tricky choice. The aggressive schedule gives you more money, at least at first. It’s perhaps best for relatively late retirements and for investors who don’t have strong desires to leave a large estate.
The conservative schedule gives you less money in the early years, but if you live long enough, it gives you considerably more later, along with a larger estate to leave behind.
By the end of the 34-year period in this study, the conservative portfolio produced a 63 percent higher withdrawal than the aggressive one – and was worth more than twice as much at the end of 2003.
I’ve shown these comparisons in workshops before, and I’ve been asked many times about a “variable variable” plan that would withdraw a higher percentage immediately after good market years and revert to a more conservative withdrawal after poorer years.
To answer this, Table 3 shows two “variable variable” withdrawal schedules. Obviously there are almost unlimited ways one could construct such a plan. These two take out either 6 percent or 8 percent, depending on the prior year’s investment performance. Here are the rules:
In the aggressive schedule, after a year with returns of 8 percent or more, the distribution is 8 percent; after returns of less than 8 percent, only 6 percent is withdrawn. The conservative schedule is identical except that returns must be at least 12 percent in order to trigger the 8 percent withdrawal.
In Table 3, you’ll see that each plan started with a $60,000 withdrawal in 1970, because 1969 was a very disappointing year. (That year, U.S. small-cap stocks fell 26 percent, the Standard & Poor’s 500 Index was down 8.5 percent and long-term corporate bonds had a negative total return of 8.1 percent.)
For the next 11 years, 1971 through 1981, these two plans had identical distributions. That is a random event, based on the fact that the portfolio’s returns in those years were always either at least 12 percent or were under 8 percent. The 1981 return fell between 8 percent and 12 percent, and from that point forward the two plans diverged. However, they both ended 2003 with similar portfolio sizes – and with plenty of assets to continue making distributions into the future.
You shouldn’t read too much into the numbers in this table. If the annual returns had come in a different order, the results could have been much different.
We’ll also look at the implications of withdrawing money monthly, quarterly and annually – real-world options that retirees must deal with. Here’s a hint: If you leave the money invested longer (meaning you take it out monthly or quarterly instead of at the start of each year), it will usually earn more for you.
In another very important part of this new workshop I have identified 16 major risks that investors subject themselves to. I show how to manage each one. For example, you can get a bad financial advisor. Your advisor may be smart, charming and well trained. But if your advisor has a conflict of interest with you, then you are being exploited. I’ll tell participants in the workshop how to recognize conflicts of interest, how to find a good manager and how to fire a bad one.
Here’s the bottom line: This free workshop will show investors how to think clearly about their investments, how to choose the right assets for their portfolios, how to choose the right distribution strategies after they’ve retired, how to avoid the biggest mistakes investors make and how to recognize and manage the biggest risks.
If you do all that well, the chances are high that you’ll be among the most successful investors, with more than enough money to live a satisfying life and leave something for your heirs.
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