Harry P., a 59-year-old government worker in Denver, is planning to retire at the end of the year.
In January, he evaluated his investments. He had already determined that he and his wife were set for life, able to maintain their standard of living while fulfilling their retirement dreams.
But what worried Harry was his portfolio. It was heavily weighted in stocks, so much so that he feared a sudden, sharp downturn might derail his retirement plans.
So Harry decided to make a change. He would move most of his government retirement account money out of stock and into bonds.
“I was amazed at how hard it was, psychologically, to make the move. Giving up the high returns from stocks was like withdrawing from cigarettes–nearly impossible,” says Harry, who asked that his name be withheld so as not to appear to be gloating about his financial success.
What’s important about Harry is not his name, but rather the situation he faced, one that millions of Americans are confronted with: the need to diversify risk and pursue safety compared with the feeling of regret from giving up the strong performance of stocks.
The success of the stock market has gone a long way toward creating that environment. People act as if good returns are a foregone conclusion, as if stock market investing is a lock.
With that mindset, any type of switch away from stocks is viewed as a loss. That means owning a bond with, say, a five percent return feels like a bad move, because the money would have brought in bigger returns elsewhere.
It doesn’t matter that stock market returns hardly are guaranteed. Just pulling the money out from the realm of bigger profits can make an investor feel like a loser.
And no matter how much money you have–and foresee having in the future–there is always some scenario you can cook up in which you could need more money. That also drives a lot of people to let money ride, even when it may be in their best interests to pull back.
“It’s really hard to make the shift and to say, `No, I will take what is likely to be a lower return in an investment where I can evaluate the outcome with some certainty,’ ” says Donald MacGregor, senior researcher at Decision Research, a Eugene, Ore., firm that studies investor behavior. “Even though we know that the safety and security would make us feel better, we tend to look at the road not taken and think you could wind up better off going that way.”
Harry P. did make the switch into conservative investments. He compared the move to going to a casino and winning his first few hands at the blackjack table, at which point “I take my money off the table and spend the rest of the time playing with the house’s money.”
In the case of his retirement portfolio, the stock market’s oversized gains of the last decade provided his winnings. He still has plenty of money invested in stocks. But he has pulled back a big chunk to make sure he doesn’t go home empty-handed.
For most investors, savings is a game in which it is hard to pull winnings off the table. Part of that is the psychology involved–the thrill of watching winnings pile up and the disappointment at seeing others do better than you–and part is basic financial planning.
In both cases, however, the problem can be addressed by answering two questions: “What is this money supposed to do?” and “How much money do I need to make it happen?”
Most people can answer the first question but not the second. Their goal is to save enough to live comfortably in retirement, but they have no idea how much money that will take.
Often, people assume that retirement will be like taking a lavish, all-year vacation. The reality usually is more pedestrian and less costly.
But armed with a good idea of what he needs, an investor can make better decisions on how to invest.
Think of it like a basketball game. If you are behind, you press to score more points. If you are winning big, you work to maintain your lead and make sure the bad guys can’t win.
Harry P., like millions of other people, is at the point at which the game is won. Unlike many people, however, he opted not to pour it on and run up the score, which could increase the extremely slim possibility that he lose the game.
“When you make the calculation and come to the conclusion that you are better off taking some money out of stocks, you haven’t yet come to the point where you feel regret,” says Meir Statman, a Santa Clara University professor who studies behavioral finance. “It’s when you go to implement the changes that you could run into trouble–where you will question yourself or think you could be better off staying put because you just might wind up with more money.”
Also, says Statman and others, you need to look at the consequences of doing nothing.
A few years ago, when my family moved to the Boston area, my wife and I had a lump sum of money from the sale of our old house. We were renting a home and planned to buy something new in about 12 months.
With that short a time horizon, the only choice for our nest egg was a money-market fund. Never mind that the stock market was booming and that our other investments were growing like weeds; we could not afford to bet the house.
So when the time came to buy the house in the community of our choice, we emptied the money-market account.
We could have lamented the fact that the worst of our mutual funds had posted a gain of more than 30 percent during the time when our money had been earning a 6 percent return. We certainly could have used that additional return.
But our money served its purpose. It got us the house we wanted in the community we wanted.
Had we invested in the stock market and lost, we would have had to settle for something less.
Remember, you don’t just save and invest for the sake of amassing money. Presumably, you want the money to actually do something, from putting a roof over your head to putting the kids through college to paying for food for the rest of your days.
As hard as it is to rebalance a portfolio, culling winners and shifting around an asset allocation to be more conservative, consider the cost-benefit analysis of pursuing the bigger returns versus the prospect of losing money during a market downturn. You may decide that there is more risk in being greedy than in losing a little potential return.
Says MacGregor: “At some point, you must ask yourself `How much is enough?’ For people who `have it made,’ more money would not improve their standard of living in retirement. Knowing that what they have earned is not going away, however, could make the rest of their life a lot easier.”
USING FINANCIAL SOFTWARE TO SET UP RETIREMENT PLAN
“Let’s see . . . what if I start saving 15 percent of my income instead of 10 percent, get an investment return of 9 percent instead of 8 and hope for inflation of 2 percent instead of 4? Could I retire 10 years early?”
Oh, if only it were so!
Well, maybe it is–you don’t know until you run the numbers. Even if your wildest financial dreams are out of reach, there may be some pleasing middle ground, attainable with a well-designed budget and investment plan. To refine their plans, growing numbers of people are turning to financial software that runs on ordinary home computers.
Three plans popular with investors are Quicken Financial Planner (listed at $89.95; order on-line at www.quicken.com), Microsoft’s Money 99 (listed at $64.95; order on-line at www.microsoft.com) and Vanguard’s Navigator Plus (which can be downloaded for free at www.vanguard.com).
– Knight-Ridder/Tribune.
