“The art is not in making money, but in keeping it.”
Let’s start with what this book is not. This book is not an “introduction to investing” book. Millions of those are out there, and they typically put people to sleep. Therefore, this book is not going to explain: What is a stock? What is a mutual fund? How do you create a family budget? Yada, yada, yada. This book was written for the millions of people who could be called the “mass affluent”—those hardworking, successful individuals and families who have managed to accumulate $500,000 to $10,000,000, and those who are focused upon working toward that kind of affluence. Through meetings with hundreds of current and prospective clients, we have seen how people accumulate small fortunes, and then frequently lose a good portion of them through bad investments and poor planning.
Many people acquire their fortunes through systematic saving in qualified retirement plans (i.e. pensions, 401k, etc.), through real estate, the sale of a small business, or an inheritance. Each of these methods of acquiring wealth is very legitimate, but none of them involve active management of your investments. The accumulation stage (birth through the end of your career) of your financial life is much simpler and more forgiving than the strategy required for the distribution and legacy planning stage that occurs during your retirement years.
Once people retire, they frequently roll over retirement accounts that were administered by their employer to an IRA where they have full control. They also sell businesses or real estate and have a lump sum of money to invest. Most people have never been in the position to invest in this way before, or at least not at this level, and not when the stakes are so high. In fact, most people’s largest assets (in order) are their home, their company retirement plan, and then cash value life insurance. What do those three assets have in common? You typically don’t look at their value every day, and they are not considered liquid by most of their owners.
What many people fail to realize when they retire is that they have just employed themselves to become the pension fund manager for themselves and their family’s future. What that means is they may no longer have the luxury of not needing to take income from their investments. When you are in this situation, your investment portfolio has in essence become your employer. The performance of your portfolio will now dictate in large part the lifestyle that you and your family can enjoy in the future. If your portfolio does not generate enough income, you no longer have the option of just working more hours or taking on a side project. Your portfolio is more important now than ever, as are other financial decisions you will be making. You have entered the major leagues of investing and you are up to bat. The questions you now need to ask are:
- How should I change my investment mix?
- How much can I afford to take from my account on a monthly or annual basis?
- From which investments should I take the money?
Professional pension fund managers face these questions each day. You now have a decision to make—you can either answer these questions for yourself, or you can hire a professional to answer them for you. It’s a tough decision whether to manage your investments yourself or to hire a professional. If you are considering doing it yourself, you should be aware of some of the mistakes we frequently see among do-it-yourself-ers.
Once people have control and liquidity, they begin to exhibit what we call “Retail Investor Behavior.” As you may have guessed, this behavior is not a good thing. Retail Investor Behavior can best be demonstrated by looking at a study by Dalbar Inc., a leading investment research firm. Its study of investor behavior found that although the U.S. stock market (as measured by the S&P 500 index) grew at an average annualized rate of 9.14% between 1990 and 2010, the average investor in the stock market only earned 3.83%. The same was true for investors in bonds. The Barclay’s Aggregate Bond Index earned 6.89% over the same 20 year period. The average investor in bonds only realized 1.01%. That is stunning! Retail investors are earning less than half the market’s return. Why is that? The investments work. The problem is investor behavior. However, before you can successfully analyze any investment or financial plan, it is imperative first to understand the psychological biases that prevent most people from succeeding at managing their own money.
The investing failures are not due to people being stupid. The majority of people we meet and work with are quite bright. Many of our clients are Ph.D.’s, engineers, lawyers, CPA’s, successful business owners and college professors. The reason why most people make poor investors is that they are human. Human beings are hard-wired to make decisions with their hearts and justify them with logic. Greed and fear rule the day. Unfortunately, the fear and adrenaline that kept humans alive when we lived in the jungle does not serve us well as modern day investors.
This book is going to explain some of the most common ways people destroy themselves (financially). We will also delve into the new and fascinating field of behavioral finance. In other words, we are not just going to list typical mistakes investors make. Rather, we are going to explain WHY people make the same mistakes over and over again. Then we will give you examples of what you can do differently so your investments remain safe and continue to grow.
Take a moment to reflect on these questions:
- Are you overwhelmed by the number and complexity of investment choices?
- Have you ever wondered why investments always seem to go down after you buy them?
- Do you always feel like you are in a reactionary mode to investing?
- Are you unsure how to find a financial advisor you can trust?
- If you hire a financial advisor, how do you evaluate his or her performance?
When you finish reading this book, you will have the answers to these and many other questions. You will be a more educated investor and a better consumer of financial services. This book will dispel many of the most dangerous myths and misconceptions about money. More importantly, this book is going to provide insights to help you become financially successful during the second half of your life. You do not have to be the typical retail investor. There is a better way, and we will explain it in terms you can understand. As Einstein said, “You should make things as simple as possible, but no simpler.”
Let’s conclude this introduction with a few thoughts about what it means to be financially successful. It has nothing to do with your current income or this quarter’s return on your portfolio. Financial success means that you can afford to live an extraordinary life and a life that you love. Financial success means that you will always be able to afford your current lifestyle. More importantly, it means that you have the financial security to live your life without financial stress. As Jerry Maguire said in the movie named for him, “I wish you my kind of happiness.”
Jeremy A. Kisner, CFP®
Robert J. Luna, CIMA®
December 1, 2011