Kimmunications

Your time horizon may be longer than you think

When choosing your investments, there are four things to consider:

 

1. Your investment objectives

2. Your risk tolerance

3. Your time horizon

4. Your temperament

 

Once you've chosen an investment that satisfies these criteria, you shouldn't make major changes to it unless one of those criteria changes. I've written a lot on my blog about several of these criteria, but today I want to focus on No. 3: your time horizon.

 

Many of us were taught that there are two phases to investing: The accumulation phase, when you can take more risk by investing primarily in equities, and the income phase, when you put more of your assets into lower risk investments such as bonds. The thinking is that your primary time horizon for investing is up until the day you retire; then you switch to living off what you've built.

 

This line of thinking is a bunch of bunk. Your time horizon for growth doesn't end when you retire; it continues for the rest of your life. (And income investing and growth investing don't have to be mutually exclusive; income reinvested is growth, but that's a topic for another day.)

 

I got to thinking again about our time horizon last week at one of our Snider Method information sessions. I had just described our investment method as a long-term approach when an audience member asked, "But I'm almost 70, and I'm already retired. Shouldn't I focus more on the short term?"

 

I told him that even 70-year-olds have a long-term investment horizon. The reason is life expectancy. If your goal is to sustain your standard of living for the rest of your life, you need to look at how long you can expect to live.

 

A recent article in USA Today detailed the life expectancy of men, women and couples who planned to retire this year at age 62. Citing data from the American Academy of Actuaries, the article said that the joint life expectancy for a 62-year-old couple is 90.7 years. There’s a 58% chance that one of them will live to age 90, and a 29% chance that one will reach 95.

 

This means that my 70-year-old guest has at about a 20-25 year time horizon for his investments -- maybe even longer. His challenge is to invest so his portfolio can sustain his standard of living for that long, taking into account inflation and the rising costs of health care.

 

Considering that the cost of living increases an average of 3.5% a year, and health care costs are rising at twice that rate, his rate of return needs to be higher than that obtained by the bond-heavy portfolio usually recommended to someone in his age group. The only way to generate that kind of return is to have a significant portion of his portfolio invested in stocks.

 

I'm sure most 70-year-olds would balk at the idea of being heavily invested in stocks. Too much risk, they'd say. But market risk is more of a concern in the short term. For the long-term investor holding a diversified portfolio, stock market risk is much less of a concern.

 

The stock market has historically been a great creator of wealth and protector of purchasing power for the investor holding a portfolio of America's greatest companies over long periods of time. Many investors don't realize that their time horizons are much longer than they think -- even my new 70-year-old friend who's already enjoying retirement.

 

SOURCE: Sandra Block, "Boomers' Eagerness to Retire Could Cost Them," USA Today, Jan. 14, 2008. http://www.usatoday.com/money/perfi/ retirement/2008-01-13-turning-62-cover_N.htm

 

Kim Snider Financial Communications makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal. Growth refers to growth of portfolio income, not necessarily growth of net asset value. Growth assumes some portion of income is reinvested. Yields do not include unrealized losses or gains.

The Performance Paradox: The Antidote (Part 3)

For the last two weeks, I've written about what I call the Performance Paradox. It goes like this: The more you want or need it, the more you try to get it, and the more you micromanage it, the worse it will be.

 

The two sides to the Performance Paradox are fear and greed. These emotions cause us to buy at tops and sell at bottoms, and to repeat that pattern over and over again. Buying high and selling low is the opposite of what we should be doing, yet most investors can't seem to help themselves.

 

This week so far demonstrates the power of emotional decision-making. On Tuesday, the Dow opened down 465 points, and just about every analyst on TV was spouting doom and gloom. Investors, afraid of losing more money, sold off their shares, only to see the market rebound the next day.

 

Think of all the money they just lost by panicking when stocks had fallen, when what they should have done was ... nothing.

 

The key to successful investing is being able to tune out the influence of our emotions. You can do that by developing a set of rules when you are sane, before you have any money on the line, and by sticking to those rules even when your emotional brain is screaming at you to do otherwise.

 

When people ask me why they should take our workshop and invest the way we do, I tell them about our true value proposition. Ours is a behavior-modification plan as much as it is an investment strategy. It's not about the performance that our investment method generates; it's how we help you behave as an investor.

 

The annual Quantitative Analysis of Investor Behavior study by Dalbar Inc. shows that the average equity mutual fund investor badly underperforms the average equity mutual fund investment. In other words, it's investor behavior, not the investment itself, that truly determines return. I could have an investment that returns an average of 30% a year over 20-30 years, but if you continually bought it high and sold it low, the fact that it averaged 30% a year doesn't matter. Your return would be much lower because you let fear and greed drive your decision-making process.

 

By creating a rigid system that you follow no matter what, even when the market is down 400 points and you feel just awful about the economy, you can avoid the behavior that sabotages most investors. If you can correct that behavior, you can improve your performance, regardless of what you're invested in.

 

Kim Snider Financial Communications makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

The Performance Paradox - Greed - (Part 2)

Last week I wrote about what I call the Performance Paradox. The Performance Paradox is: The more you want or need it, the more you try to get it, and the more you micromanage it, the worse it will be.

 

There are two sides to the Performance Paradox. One is fear, which I discussed last week. The other is greed. Let's see how these two work together to decimate investor performance.

 

John is a 45 year old employee of a defense contractor here in town. His company offers a 401(k), which he maxes out each year. John characterized the performance of his 401(k) as "awful" and his performance as the manager of his 401(k) as "mediocre at best."

 

"Why do you say your 401(k) is awful?", I asked.

 

"I keep hearing how the Dow is at an all-time record high but my 401(k) is nowhere near an all-time high. I must be doing something wrong."

 

"How do you decide what funds to pick within your 401(k)?"

 

"I pick the one with best track record over the last couple of years?"

 

"Only one?"

 

"Yes. I go for the one going up the most. But as soon as I get in them it seems like they stop going up."

 

"So then what do you do?", I asked.

 

"I sell them."

 

"And then how do you pick the next one?", as if I didn't know the answer.

 

"The same way."

 

It didn't take a lot of detective work to spot the cause of his sub-par returns. His portfolio decision-making was being driven by greed. Of course, this process for picking investments flies in the face of what we know to be true - namely that markets are cyclical. Trees don't grow to the sky and all investments go through periods where they do well and others where they do not so well.

 

So take a mutual fund that has out-performed the market in each of the last three years. People start to notice. The fund manager gets written up in Barron's. The fund makes a bunch of lists in magazines like Smart Money and Forbes, with titles like "The 10 Funds You Must Own This Year Unless You Want to Be Poor and Stupid" and money comes pouring into the fund from people like John.

 

This is great news for the fund company - big cash inflows - exactly what they hope for. They make a lot of money and the fund manager gets a multi-million dollar bonus.

 

But it is bad news for the new investors like John. It’s a death knell. Big inflows are a contrarian indicator. They almost always signal the end of the run.

 

What John does not consider is it is absolutely impossible for the above average performance to continue indefinitely. The aggregate return of investors is the stock market return less transaction costs. There is no persistence in stock market returns. The funds which do well in any given period are typically the worst performer in subsequent periods. In short, the results are basically random.

 

So driven by greed, John buys the hot fund. When it fails to meet his unrealistic expectations, as it inevitably will, he sells it. What has he just done? Bought at the top and sold at the bottom. If you look at the fund's performance on Morningstar it will seem to have done quite well. Look at John's performance and it won't be anything close.

 

This pattern is well documented in an annual study by Dalbar called the Quantitative Analysis of Investor Behavior or QAIB for short. What the QAIB tells us is that in any rolling 20 year period the average investor underperforms their investment by a significant margin because of a persistent pattern of buying high and selling low.

 

This pattern can be driven by greed, as in John's case, or by fear, as I wrote about last week. Either way, the result is the same.

 

What is the answer?

 

The one thing I know for sure about investing is to make money over the long run you have to stay put. Successful investing requires discipline and patience. As I said last week, investing in the stock market is a winning strategy over time, just not all the time.

 

The investor who moves in and out of various investments because the one they are in now doesn't feel good or because they think the grass is greener somewhere else will always get the opposite of their intended result. That is the Performance Paradox.

 

Next week, we'll talk about the antidote. Stay tuned.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

The Performance Paradox - Fear - (Part 1)

When the markets re-opened on September 17, 2001, the Dow was down, at one point, 850 points and the S&P lost 5% of its value. I remember remarking to my husband (boyfriend at the time) that I felt as if I was moving through Jell-O. Much of what we thought we knew about our world had just gone out the window. No one knew what was coming next. Would there be more attacks? Was this just the beginning? And even if there weren't, how would the economy withstand such an unprecedented disruption?

 

That week, a number of our clients called us. Some just wanted to talk. Others wanted to know what to do. Should they continue with the Snider Investment Method as if nothing has happened? Should they sell their Snider Method positions? Should they liquidate their other stock market holdings?

 

Our response, as it always is, was to stay the course. There was no reason to alter the strategy or do anything different. After all, our investment objectives, tolerance for risk or time horizon did not change when those airplanes slammed into the World Trade Center. I put together a 60 second radio spot that aired on local radio before the markets reopened which told people we would be buyers of stock when the markets reopened.

 

Many people, clients and otherwise, thought we were nuts. Some called to say they were dumping their portfolios. We advised strongly against it, but it was their money. They could do what they wanted.

 

Those who dumped their portfolios did so out of fear and are classic examples of one side of what I have come to call the Performance Paradox. The Performance Paradox is that the more we react to the short term performance of our portfolio, either out of fear or greed, the worse our long-term performance will be.

 

The person who invests from a base of fear, in other words is so afraid of market losses or is so obsessed with short term performance, that he sells every time an investment goes down creates a pattern of turning temporary losses in value into permanent losses of capital. Do this over and over again and you will continually turn winners into losers.

 

What is the answer?

 

To be a successful investor, you must be an optimist. You must recognize and internalize that we live in the greatest, most transparent economy in the world. There will be downturns and tough times - no question. All of us have a tendency, especially as we get older, to think the world is going to hell in a hand basket.

 

And yet, we also know that ten years after any economic disruption - whether it be the Great Depression, the 1987 crash, the currency crisis of the late 1990s, September 11th or whatever - we can look back and we will not wish we had sold. Instead we will wish we had invested everything we had at the time.

 

This is not to say that investing is risk-free and that even the most optimistic among us won't go through periods of doubt. By definition, we will experience severe declines periodically in the future. Investing in the stock market is a winning strategy, most of the time, but not all the time. And those down years can be hard to ignore.

 

If we could accurately predict when those down years would occur, this discussion would be moot. We would simply get in ahead of market upturns and get out ahead of the downturns. But of course, no one can accurately predict when the downturns will come or how long they will last. As Nobel Laureate Paul Samuelson said, "The stock market has forecast nine of the last five recessions."

 

What we can predict is, if you are an optimist who takes a long term view of the market, you will prosper over the years because you will have found a proven strategy for success. The investor who takes the opposite approach - who is bound up in fear and as a result monitors his portfolio constantly and reacts out of fear to short term declines in value, will not be successful over the long run.

 

This is the Performance Paradox. The more you want or need it, the more you try to get it, and the more you micromanage it, the worse it will be.

 

So which are you? Do you take an optimistic long-term view of the market? Or do you try to micromanage the short term performance of your portfolio?

 

Next week, I'll look at the flip side of the Performance Paradox - greed. Then we'll talk about the antidote. Stay tuned.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.