Market Minute on Finance Friday

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The Dow Jones Industrial Average quietly moved to a five year-high as investors poured billions of dollars into equity funds. The calm economic backdrop on Wall Street this week gives us the opportunity to take a broader perspective on investment planning.

A report from the United Nations International Labour Organization came out this week, forecasting global unemployment to rise by 5.1 million this year. The increase means that an estimated 200 million people worldwide will be without jobs by year’s end.

These statistics highlight the importance of setting multiple investment goals and making a firm commitment to take action on them. The two most basic and vital goals for most Americans are saving for retirement and setting up an emergency fund.

Both are important and need to be considered together as part of the investment-planning process. Because building up a rainy-day fund is a short-term goal, and retirement planning is a long-term goal, different investment choices are likely to be involved. However, the process is the same in both cases— it starts with making a conscious decision to save and taking concrete actions to do so.

Conditioning yourself to set goals and have the discipline to pursue them is a habit that will pay dividends in the future.

The Uncertainty of Retirement

We’ve heard from quite a few of you lately that the hardest part of planning for retirement is that you have no idea what you want it to be.  You’re pretty sure you don’t want to spend it sitting in a rocking chair and it’s looking less and less likely that you’ll stop working entirely the day you turn 65.  But beyond that, you can’t say for sure. 

That’s why we put the book Just Start: Take Action, Embrace Uncertainty, Create the Future on our reading list not too long ago.  Written by Leonard A. Schlesinger, president of Babson College, Charles F. Kiefer, president of Innovation Associates, and Paul B. Brown, who is a long-time contributor to the New York Times, the book is primarily written for those who are looking for entrepreneurial strategies.  But it addresses a familiar challenge: How to succeed at work and life in an increasingly unpredictable world.

Using both quantitative and anecdotal research, the authors identify a pattern common among entrepreneurs facing uncertain futures:

1.     Act

2.     Learn (from that action)

3.     Build (upon that learning)

4.     Act again

The authors contend that this approach is akin to serial experimentation, which mitigates risk and improves the likelihood of success by biting off small challenges and rapidly adapting to the learning that each experiment yields. 

We think this model has real potential in the context of retirement planning.  Unfortunately, the most common retirement “planning” strategies used today are:

  • Set It and Forget It: Contribute to your company 401k, make changes every few years (when prompted), hope for the best
  • Fire Drill: Put off retirement planning for as long as possible, panic as you get closer to 65, depend on Social Security

While the set-and-forget approach is preferable to the fire-drill, neither is wise. 

Taking into account that you may not be entirely sure of what you want retirement to be, and acknowledging that you are likely to experience a number of changes (good & bad) along the way, it makes sense to approach retirement planning in frequent small cycles like those described in the book. 

Here are some ideas to get you moving in small steps:

  • Find inspiration:  Talk to your friends and family about retirement.  Ask your friends how they’d spend their time in retirement and what they’re planning.  Ask those questions with your friend’s spouse or partner in the room.  Do their ideas of retirement line up?  If you’d rather do it online, try The Life Goal Challenge app on Facebook and invite your friends, family, and partner to do the same.
  • Take your best shot: Take what you’ve learned and get started.  Follow our guided goal-setting process for retirement and see where you land. 
  • Recalibrate:  It’s a good idea to go back through the goal-setting process at least annually to see if all the assumptions, attitudes and circumstances that shaped your goal and investment strategy still hold true.  But don’t wait for a year if something significant happens, like getting married, getting a raise, buying a home or having kids.  You can revisit the goal-setting process at any time. 

Retirement may still be something of a mystery to you but you’ll have made that first step and gathered some learning.  And that makes the next step easier.  If you get a chance, take a look at Just Start.  That counts as a step, too. 

Market Minute on Finance Friday

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When you opened your first paycheck of the New Year, there’s no doubt you noticed that it got smaller. The expiration of the temporary reduction in Social Security taxes implemented in 2010 is now taking a bite out of everyone’s wallet.

The need to make up the difference has already caused consumers to change their behavior. At the grocery store, they are bypassing name-brand goods in favor of store-brand offerings. In retrial stores they are choosing lower-cost goods over luxury items. Some working-age investors have even responded by reducing contributions to their retirement plans.

While reducing the amount you save and invest is a quick and easy way to make up the missing money, this short-term fix is not a good long-term investment strategy. The power of compounding, which basically means that your investment generates earnings and then those earnings generate earnings of their own, is one of the most powerful wealth-building tools. When you invest less money, you reduce the effects of compounding. Putting away 2% less each month could be costly over the long term.

Investors who are still saving for retirement are likely to be far better off by addressing the short-term hit to the wallet by spending less and maintaining or increasing their level of savings. Granted, it may not be easy to do, but when you reach retirement age you will probably be glad you did.

Head vs. Heart – Is Having a Child Part of Your Financial Plan?

Nadia Taha and her husband are not having children.  They announced it in a recent editorial in The New York Times where Nadia works as a personal finance blogger and editor.  What interested us about the article was not that a career-minded American woman in her late 20s announced she was choosing not to have children.  There have been plenty of those lately.  No, it was her bold admission that the decision was a financial one that got a lot of attention. 

Presumably, the newly married couple sat down, discussed their life goals, and began planning for what it would cost to achieve them; including what it might cost to raise a child.  Still, that cost estimate alone might not have led to the decision to remain childless if Nadia and her husband had truly wanted to be parents.  In her blog post the author admits that she has no strong desire for children.

Photo Credit: New York Times

For many couples, however, the decision about whether or not to have children involves a tug of war between the desires of the heart and the logic of the head—or wallet, in this case. 

Head vs. Heart:

In fact, the battle between head and heart is a common occurrence in decision making across the board, if only subconsciously.  And while the heart often gets a bad rep in the context of sound judgment, it has an important role to play:

  • Raising a red flag in response to a perceived threat
  • Reminding us of the emotions and feelings we experienced from similar situations
  • Helping to form our values and principles

The heart can get us in trouble, though, when it completely trumps our rational side, resulting in biases that don’t serve us well.  Take regret bias, for example: we stubbornly avoid admitting that we made a bad choice, and refuse to make a change that would actually be in our best interest.  Or confirmation bias, which is a tendency to look only for information that supports a decision we’re leaning towards (rather than looking for information that might challenge that choice). 

If you’re faced with a decision and the answer isn’t as clear to you as it seems to be for Nadia and her husband, the following advice from behavioral finance researcher Philip Cheng[1] might help you get your head and heart working together to make good decisions:

  1. Commit to making the best decision. 
    Seem obvious? Maybe, but that doesn’t necessarily make it easy. Defining your goals, weighing trade-offs and making decisions takes a good deal of thought and effort.  You may be tempted to put off those tough choices until you’re faced with a deadline or crisis.  But by then, it may be too late for you to take steps that will help you reach your goal.  Make the commitment to do the work now.  
  2. Sleep on it. 
    When you’ve settled on a choice, don’t act on it immediately.  Let your unconscious mind mull it over.  That incubation time can result in even greater clarity and ideas that may either reinforce your decision or convince you to make a change.
  3. Revisit your decision. 
    Put your decisions to the test by identifying and challenging any assumptions you’ve made.  Consider the personal goal you’re trying to achieve.  How will your choices affect the likelihood of achieving that goal?  

Regardless of what you want to do and achieve in your life, chances are that you’ll face tough choices along the way that will force you to make trade-offs.  Your head and your heart should be on the same page. 


[1] Cheng, Philip.  “Improving Financial Decision Making with Unconscious Thought: A Transcendent Model.” Journal of Behavioral Finance, 11:92-102, 2010.

 

Market Minute on Finance Friday

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The stock market has been celebrating since Congress forged an agreement on tax rates last week. However, we face several additional fiscal hurdles in the months ahead. Automatic spending cuts have been postponed, but only for two months. And the government has already run into its debt ceiling, which only Congress can raise. The Treasury has taken ‘extraordinary measures’ that should postpone the day of reckoning until late February or March. Unfortunately, investors may recall how ugly the last debt-ceiling impasse was in 2011.

With the fear that surrounded the fiscal cliff tax negotiations as a guide, investors need be aware that similar sentiment may be associated with the debt ceiling. Issues such as these drive home the sometimes stark differences between short-term market sentiment and longer-term market results.

In fact, 2012 was a perfect example of the clash between reality and sentiment. While the entire year was marked by concerns over European finances and U.S. politics, the S&P 500 rose by 16%.

For investors, the lesson here is that political noise does not determine investment success—fundamentals do. The road ahead may be bumpy at times, but don’t let that distract you from a sound investment strategy.