Welcome to back-to-School season!!! Merriam-Webster.com defines learning as, “to gain knowledge or understanding of or skill in by study, instruction, or experience.” As we prepare our families to begin their learning journey, I believe it is important to remind you of the benefits of fully understanding and knowing YOURSELF.
From experience, I have found that investors rarely fully understand themselves, the values they hold dear and specific goals they seek to accomplish. As it relates to allocating your hard-earned assets, investors typically believe a beginning process is sitting with an advisor and answering a risk questionnaire. Investors believe their risk questionnaire dictates how they should invest.
I believe the approach outlined above is backwards; it misses the PERSONAL in personal financial planning! I suggest clients begin their journey to financial freedom by appreciating a deeper understanding of themselves, their values and their emotions.
“Concentrate your energies, your thoughts, and your capital. The wise man puts all of his eggs in one basket, and watches the basket.”
– Andrew Carnegie
I work to help my clients align their decisions with their goals, and their goals with their values. I do this in a way that prepares them for the certainty of uncertainty.
I believe that people who reflect on their values before making a decision of almost any kind, including a financial decision, make better decisions. Values reflection won’t make you smarter, but values reflection will make you more rational.
A Vanguard study found that the dominant factor in portfolio growth is saving and investing behavior. Accordingly, the amount people save and invest, as well as the duration of their investment matter more than all other factors combined. Furthermore, providing behavioral advice to clients in practice has the largest value-add relative to “average” client experience. Behavioral coaching had a larger impact on client return than any other practice, including asset location, rebalancing, spending strategies, and expense ratios.
Behavioral financial advice has been around for a while. It stands beside traditional finance. Financial advice has been based on a Nobel Prize winning economic theory model – Modern Portfolio Theory. All things we have learned about Asset Allocation, Efficient Frontier, and Modern Portfolio Theory are still important. However, they are all based on the premise that investors will make rational decisions without bias and base decisions on risk and reward potential. In reality, people frequently behave irrationally, and irrational behaviors are often stimulated by extreme emotions, either positive or negative. Behavioral financial advice helps understand the reality that people often behave irrationally and in a biased manner. It also helps us realize that people are more averse to loss than we originally thought.
For those investors who have already worked through the process of greater self-awareness, let’s discuss a few data points to consider as you navigate through the investment markets.
On July 31, the Federal Reserve (Fed) cut interest rates for the first time since the Great Financial Crisis. Federal Reserve Chair Powell defended the rate cut as a “mid cycle adjustment to policy.”
About $15 trillion of government bonds worldwide, or 25% of the market, now trade at negative yields, according to Deutsche Bank. This number has nearly tripled since October 2018.
New UK Prime Minister Boris Johnson says he is committed to leaving the EU on October 31, even if no new “Brexit” deal is renegotiated, and an escalation in trade tensions between the United States and China are within a list of news items that can go on and on. The point is, you need to stay aware of not just the headlines but go beyond to work through their possible ramifications (and if you can’t, engage with someone who can on your behalf).
I find Chair Powell’s comment of a “mid cycle adjustment” interesting – we are currently in the longest U.S. expansion in history (122 months)! The second longest expansion in history was 120 months (starting in the early 1990s to the dot-com bust). The average expansion is around 60 months. What do you think and how are you allocating your investable assets?
No two market cycles are the same. History shows the drivers that fueled the bulls’ runs and the catalysts that ends them have always been different. However, investor behaviors are often the same.
Investors often have ideas of what constitutes an optimal portfolio. A conventionally held allocation is to have 80% stocks & 20% bonds (or 60% stocks & 40% bonds). I’ve found that investors may blindly choose this but they don’t actually realize the returns they expect. I believe this is largely due to the allocation’s volatility leading to sub-optimal behavior. This is evidence that why understanding your values and emotions is so important.
If you seek help gaining clarity on how aligning your values and emotions, while keeping your personal biases in check, work towards your investment goals, email me at [email protected]. I would be honored to share my process.
