12 Dec 2014 Is Your Financial House in Order?
Which of the following do you believe is the most important aspect of ensuring the quality of your financial future?
A. Saving diligently
B. Working longer
D. Achieving better-than-market returns
E. Designing an efficient well-allocated portfolio
F. Excellent financial planning
G. Winning the lottery
H. None of the above
Interestingly enough, the answer is H, none of the above. The most important requirement for achieving the financial future we desire is overwhelmingly ourselves, or more specifically, our behavior. Despite our success in achieving A through F and good luck in winning a lottery, if we don’t have a firm grip on our behavior the odds of our meeting our financial goals fall flat on their face.
How well we know the importance of planning for the future, and some of us actually do it. Whether it’s as simple as a once a year check-up of our 401Ks or as involved as regular visits with our financial advisor and planner, estate attorney, and tax planner, our efforts are practically worthless if we fail to execute the plans we’ve made. We may say we will save X dollars each year, but at the end of the day if we fail to modify our spending behavior, there may be little or nothing left to save.
A friend sent this recent post about how money can literally burn a hole in our pockets. Spending rather than saving is but one of a myriad of ways people fail to execute the very plans they set out to follow. The danger in these kinds of behavioral shortcomings is subtlety. Without the oversight and accountability of a financial professional analyzing the impact of plan failings, the lone individual often remains too focused on the present to study the long-term impact of his minor failings in plan execution.
The most dramatic form of behavioral mistake is how we react to volatile markets; whether rising or falling. The annual Dalbar study is the most famous of investor behavior studies. It quite simply compares the historical average returns of stock and bond funds to the average returns the individual investors in those funds actually received. In the latest study of the past 20 years, The S&P 500 returned 9.22% ended in 2013 while the average equity fund investor received only 5.02%. The difference is known as the behavior gap. Investors allowed panic to drive them out of stocks when markets were declining and to buy in later at higher prices when they were rising. They sold at low prices and they bought at high prices. Sadly the results are surprisingly similar every year.
The issue that we face most often is the legitimate fear caused when markets collapse. Nobody likes to see their hard-earned and long-time appreciated dollars erode when markets turn sour. But these are the very times when the solidity of our behavioral foundation is tested and exposed for its failings. If we have not diligently developed a comprehensive financial plan that describes our aspirations and priorities, and more importantly committed our behavior to that plan, we are far more likely to suffer cracks and shifts and failures when the difficult testing comes. Financial houses are only as strong as the behavioral foundations on which they rest.
The behavioral mistakes above represent but a couple of those we see people make regularly. There are many more.
In fact, RP Seawright, a money manager, lists 10 of the most common behavioral biases we suffer.
Our behaviors are the product of our personalities, years of development, and bad habits.
Left to our own devices, we are infinitely more likely to hold to our comfortable pathways with little regard to where they lead us. Alternatively, when we engage a qualified professional advisor in the construction or maintenance of our financial house, one who has our best interests at heart, we gain not only expertise and process, we gain a partner who walks with us helping us to repair the cracks of our behavioral mistakes, holds us accountable to the execution of our plans, and most importantly, bring us back to bedrock when our foundation is crumbling. “As iron sharpens iron, so one person sharpens another.” Proverbs 27:17.
We hope you and your family are enjoying this Christmas season. As you reflect on the year past and look to the one ahead, please include your financial foundation high on the list. Come see us here in Raleigh and let’s ensure that all you value rests on a very strong foundation.