From Retirement Now Newsletter December 23rd 2021
With markets doing as much fluctuating as they have been over the last few months I thought it’d be a good idea to discuss behavioral finance.
Which is really the study of what affects the financial behavior of investors.
There’s a lot of different aspects to it. One book that I enjoyed reading is “Your Money & Your Brain” where the author goes over many different ways our brains can trick us based on what type of information we are given.
For instance, there have been studies that show people think they can predict what the next flip of a coin will be based on what the previous flips of the coin were.
So if you saw a lot of “heads” you might assume there’s a higher likelihood of flipping a “tails.”
Yet from a probability standpoint, each flip has a 50/50 chance of being heads or tails.
And this is just one example.
One behavioral bias can be overconfidence. This is when a person has been experiencing very good investment returns for a while, and they become overconfident and take on more risk than they probably should be taking. The positive reinforcement from prior gains blinds them to the risk they are really taking in their portfolio. If they are being too aggressive, based on their age and life stage and needs, they could literally be just one market downturn away from taking losses that could be more than they could handle.
Another behavioral bias is herd mentality. This often occurs when there is a sustained bull market. It looks like everyone is making money. So the investor decides to jump in and be part of the herd. But to do so, they have to buy the stocks at higher prices due to all the recent past growth. And not only this, but they may be taking higher risk on their portfolio than they could stomach. Which could ultimately set them up to sell when prices start to go down again… following the herd in the down direction this time.
Both of these types of behavioral issues have the potential to really mess up a retirement portfolio.
The solution to this is to follow a plan. This plan would include:
-taking into consideration how much growth you need to sustain your lifestyle in retirement
-investing in a way that is better suited to support consistent withdrawals to supplement your Social Security and pension
-it also includes proper diversification so not every aspect of your portfolio goes down (or up) at the same time or in the same amount
-rebalancing your portfolio back to its proper allocations. If stocks go down they will comprise a lower percentage of your portfolio. So rebalancing in that case would involve selling some of your bonds to buy some additional stocks at their lower price. Rebalancing is an easy way buy low which all investors want to do.
-very importantly take a long-term perspective with your investments. In the short-run markets are unpredictable. And trying to guess where they may go on a week to week basis can lead you to make some bad investment decisions.
Very simple advice, but due to behavioral bias this simple advice can oftentimes be very difficult to follow.
And if you need help with putting a plan together for your retirement feel free to click here and book a time for us to chat.
For those of you that celebrate Christmas like I do, I wish you a very Merry Christmas.