Independent Wealth Management
Who scrutinizes your investments, designs and tests your retirement and education plan, searches for new investment ideas, patrols insurance agents and mortgage brokers, shows you strategies designed to reduce your investment costs and income taxes, monitors your 401(k), promptly responds to your email, provides one monthly statement, day-to-day net performance across all of your accounts and does all of your paperwork...We do!
Leverage has its Risks
The bear stock market of 1980-1982 (Dow 776) ended in the fall of 1982. A short time before, BusinessWeek issued a cover story proclaiming: “The Death of Equities”. That’s how America felt then, because risk-taking had become so out of favor. Investment expectations had become so low. A short time later, the greatest bull market in history began!
The pace of that great movement of dollars into stocks, which really started in 1982, picked up speed in 1995. By this time, the fear of taking risks had disappeared, but there was still at least a reasonable respect for risk. But that respect quickly dissipated. So much wealth had been created in the world over the preceding 20 years from spreading prosperity, rising asset values, and business success that the appetite for risk-taking started to accelerate dramatically. The “story” was the internet. It was going to revolutionize the world and create never-ending wealth which would grow to the sky. That created the first bubble.
The popping of that bubble had some fairly predictable, as well as some unanticipated, consequences. The foundation was in place for the perfect storm, the creation of the second bubble – “alternative” investments. To fuel this second bubble, we had the combination of a laissez faire government and the unlimited, cheap money made available by the Federal Reserve in its panicked response to the bursting of the internet bubble. These funds were made available for speculation in all manner of alternatives to stocks. Fed Chairman Greenspan sold our political and business leaders on the idea that big business was infinitely trustworthy, that derivatives reduced (rather than increased) systemic risks in our financial system, and that regulation would stifle the forces of markets. Thus, interest in hedge funds, private equity, highly-leveraged real estate investments, commodities and foreign stocks soared, creating the next bubble. The “story” this time was that in China, India and other emerging markets...
Sequence of Returns Matter
Getting off on the right foot is nowhere more important than in retirement. This is true in general, but especially about portfolio returns. The better the portfolio returns in the early years of retirement, the better the chance of having the picture book retirement scenario we all strive to create. If this is so, why do so many portfolio illustrations use an average rate of return of 8%? Not nearly enough information for retirement income planning purposes. How do portfolio projections differ before and after retirement and what are the factors that impact portfolio sustainability? A quick look at these issues can give a better understanding of recommendations for withdrawal rates, multi-tiered income strategies and other retirement funding techniques that can be utilized to secure reliable retirement income.
There has yet to be a period of time where the market consistently returned 8% per annum. But the popularity of using 8% average rate of return for financial illustrations is very common. These simple projections are adequate for pre-retirement portfolios as the fluctuations in returns have less impact during the accumulation phase. Ideally, with regular contributions and average market returns the portfolio will grow because it only has to contend with fees and tax expenses. The added burden of withdrawals that begin upon retirement is the major differentiating factor on portfolio performance. Contrary to the accumulation phase, once withdrawals are added to the mix, the timing of the returns becomes dramatically more important. To understand why, an explanation of the components used in retirement income simulations will be helpful. Retirement income simulations have at least four components...
1987 Stock Market Crash
On Monday, October 19, 1987, the Dow Jones Industrial Average* took a 508-point nosedive, falling 22.6% in a single day. The following Friday, at the end of a volatile week, “Wall Street Week” with Louis Rukeyser looked at what was behind the crash that came to be known as Black Monday—and what lasting lessons it might teach us. (You can watch the entire October 23, 1987, "Wall Street Week" episode at the end of this article.)
Although a number of issues—rising interest rates, the trade deficit, budget problems and leadership worries—dominated economic discussions in the months preceding Black Monday, no one single event seemed to cause it. The only major external developments over the weekend preceding the crash were a U.S. attack in the Persian Gulf and Treasury Secretary Jim Baker starting a public feud with monetary authorities in West Germany.
Still, the losses continued in the days after the crash...
Loss Aversion, Anchoring and Hope
How could this be? While there are a number of contributing factors for the significantly reduced individual investment returns, many of the most common behavioral causes point to loss aversion, anchoring and mental accounting as most damaging. As investors, we don’t enter the markets to purposefully earn below average returns. Nevertheless, many fail to achieve the desired returns they first had in mind.
Rafael Velez
in Behavioral Finance
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