Lower Bar Means Easier Results

If you were to open your third quarter 401(k) statements, and I hope that you do, you will find that your balance in your retirement plans has jumped significantly from its lows from the year ending 2008. This would, to the untrained eye, point to a recovery led by the stock market.

And the stock market has recovered - to a degree. Yet, expecting this to reflect into the economy that we experience day in and day out, is not there. And may not be for months. Why is this? The full article can be found here.



Paul Petillo is the Managing Editor of the BlueCollarDollar.com

Why Investors Do What They Do: Investor Optimism

A Recent Gallup poll tells it all. Well some of it anyway when they suggest: "The sharp decline in Gallup's Index of Investor Optimism in June -- particularly the plunge in expectations for the economy -- suggests that investors may be losing some of their hopes for an immediate improvement in the U.S. economy later this year." In the last in our series on why investors do what they do, we will examine optimism.

According to the Gallup website, the survey for "The Index of Investor Optimism results are based on questions asked of 1,000 or more investors over a three-day period each month." Although these individual snapshots can help us see where we were, only optimism propels us forward. Unfortunately, these looks back in time have an effect on how we make future moves.

While we may see it as a screenshot of how we invest, the real hidden knowledge behind the poll is consumer spending. Asking questions such as whether you will be able to achieve your investment targets over the next twelve months requires you to know what those goals were over the previous twelve months and during that period, you switched gears (and how many times). The thousand who were surveyed were also asked to project those hopes and fears into the future five years from now.

Key to achieving any sort of optimism when it comes to investing is job security. With one in ten Americas out of work (a number that is without a doubt, much higher due to the lack of jobs for those entering the workforce for the first time and unable to collect benefits and for those who are disparaged and no longer receiving any assistance), stability of income and the potential for raises play a significant role in how we look ahead. Bernard Baumohl in his 2007 book "The Secrets of Economic Indicators" calls the poll not only intriguing "it measures the attitude of private investors" yet it "also happens to the one of the least known."

Optimism is a mood, a feeling that offers us hope. Richard L. Peterson author of "Inside the Investor's Brain" writes that "investor optimism about the stock market's future declined in tandem with prices". He continues by suggesting "intellectual assessment ("overvalued") is decoupled from their underlying feeling of optimism ("it's going up")."

In an essay written in 1903, titled Optimism, Helen Keller calls optimism "the proper end of all earthly enterprise. The will to be happy animates the philosopher, the prince and the chimney sweep." And while I don't want to throw water on those thoughts, optimism has a dark side when it comes to our investment behavior. Coupled with all of the investor behaviors we have previously discussed here, optimism can wreck the most havoc to a long-range portfolio, in particular one built to grow for retirement.

Morningstar recently reported that "Diversified Emerging Market funds benefited from a $4.9 billion inflow vs. a net outflow of $2.6 billion in 2008." Emerging markets will always be the quickest to recover in part because of their bargain basement prices and one of the few places where risk remains risky. In a previous month's post, I warned about some of these problems and how emerging market mutual funds might not all be full of stocks from countries that are actually emerging.

Optimistic investors have also begun to channel money into more riskier bond plays "Junk bond inflows have increased $12.6 billion in 2009 vs. a rise of $1.2 billion in 2008" and Morningstar also reported that "Investors have piled in $7.8 billion into natural resources and precious metals funds after withdrawing $2.1 billion from the same category in 2008."

Chasing returns, at least past returns is also part of the problematic herd mentality and feed directly on optimism. Pessimism, which every knows is the opposite of our topic, also gives investors a sense of needing to follow what other investors do.

Optimism will not ride the coattails of this recovery. Instead, any recovery will be the result of it.

Retirement Planning and the Hope of Outliving Your Money

What makes us, as investors, so optimistic when we shouldn’t be and so pessimistic when we still have control over our retirement destiny? Consider these thoughts from a recently published online survey of 2100 adults ranging in age from 55 to 70.

Chances are, if you are retired, you often find yourself feeling hopeful about your future (48 percent) than your cohorts who are still working. Only a third of those who are still in the workforce see themselves as well positioned for the future despite the fact that many of the respondents still have ten years to complete their retirement plan.



The numbers get worse from there with much of the late aged workforce exhibiting far less confidence about where they are and where they hope to be that their retired counterparts. In fact, if you are still working, half of those questioned are worried. The respondents it should be noted had “household assets of $75,000 or more, excluding the value of real estate holdings”.

It is generally believed and certainly well touted among those who write about personal finance – myself included – that the stock market is the single greatest opportunity to get from point A (which seems to be the point of greatest concern) to point B (reaping the benefits of adding to accounts that grow over time, compounding and providing wealth that any other means simply cannot give).




But these folks are mostly frightened about their abilities (43% of those still employed, 28% of those that are not) and are unwilling to let trust the equities markets to live up to their billing. Almost half feel this way.

What is most problematic is the inability to make good estimation about how long we will live beyond the day we first begin drawing those accounts down. Many retired people are pulling a full 10% from those savings annually. This is far beyond the recommended 3-4%, which would get them well into two decades of after work income. Forty percent of those retired felt confident that they would have enough money. Yet they also found themselves very concerned about where their health was headed.

Retirement Planning and Speculation

Once you understand the way risk and reward operate – or better, how more risk might mean more reward, the tendency is to assume more risk is almost too tempting to avoid. This is often done, in many cases with the full knowledge that increased risk does not always result in increased reward. In other words, once you grasp the seductive power of increased risk, many investors choose to discount the downside of the equation. This can be incredibly dangerous when it comes to your retirement portfolio.

Consider the word speculation. Speculation (spek'yuh-LAY'shuhn) n. has several definitions. The first is the act of speculating or the contemplation of a profound nature, a conclusion, opinion, or theory reached by speculating. We think therefore we speculate.



The second definition is much more dangerous. It involves the engagement in risky business transactions on the chance of quick or considerable profit. Jacob Freifeld’s 1996 paper on the subject of behavioral decision making titled “Speculative Bubbles: Financial Genius Before the Fall" came well in advance of what was to be, at least until the sub-prime mortgage mess began to unfold recently, the greatest market bubble of in recent history.

He wrote about the theory of speculation: “In some cases this financial innovation is replaced by changes in government policy that either favor easy credit or lower taxation, stimulating rapid business growth. Whatever the case may be, a financial atmosphere of tremendous supply combined with demand for some desirable asset, be it stocks, real estate, or even rare tulips, gives birth to the speculative bubble.”

Many financial writers, myself included have alluded to the lessons of the tulip. Tulips became the craze of the wealthy in the early 1600’s, so much so, that if a person of means did not own a collection of these rare flowers, they were considered uncultured. The demand for these exotic bulbs grew into speculative and historic proportions.




Charles Mackay, in his book “Memoirs of Extraordinary Popular Delusions and the Madness of Crowds” published first in 1841 wrote: “The demand for tulips of a rare species increased so much in the year 1636, that regular marts for their sale were established on the Stock Exchange of Amsterdam, in Rotterdam, Harlaem, Leyden, Alkmar, Hoorn, and other towns. Symptoms of gambling now became, for the first time, apparent.”

There is, however no place for speculation in your retirement plan. The fact that they exist at all, is the largest hurdle any investor, especially one interested in building his portfolio for retirement, has to face. As I mentioned previously, the presence of a bubble or the effects of its aftermath tend to leave many investors indecisive.

Even as he wrote his paper, he wondered about the state of the stock market. “Currently the U.S. stock markets are in the late stages of what looks like a speculative bubble.”



While I go into great detail (in the book) about what is important to consider when bubbles exists, and how to invest your way through them, folks like Mr. Freifeld will sound warning bells well in advance of the impending disaster. But it is something you can ignore.

If your retirement planning is based on a conservative approach, a common sense approach if you will that rises above speculation, you will have no need to pay heed to those warnings. Believe it or not, you can win in any market situation.