Emotional Decisions About Money Can Have Unintended Consequences

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Emotional Decisions About Money Can Have Unintended Consequences

A recent study by Northwestern Mutual found half of Americans are less financially secure than they thought they would be at this point in their lives. This study is released at the same time the percentage of Americans saying they hold individual stocks, stock mutual funds, or stocks in their 401(k) or IRA fell to 54% in April — the lowest level since Gallup began monitoring stock ownership annually in 1999. Is there a connection between these two reports?

Source: Gallup. Results are based on telephone interviews conducted April 7-11, 2011, with a random sample of 1,077 adults, aged 18 and older, living in all 50 U.S. states and the District of Columbia.

The irony is these reports are coming out at a time when the stock market has reached record highs. During one of the best four year runs in recent history, fewer people own stocks and are feeling less secure financially. A recent survey by the Employees Benefit Research Institute says 28 percent – the highest number of Americans ever recorded since the annual survey began 23 year ago say they have no confidence at all in their ability to afford a comfortable retirement. Worse yet, the survey showed that an alarming number of Americans intend on working longer in order to fund retirement — 36 percent versus only 11 percent in 1991.

The Gallup report revealed only one in four Americans believe stocks are a good long term investment while one in three believes real estate is the best long term investment. The recent Journal of Wealth Management paper “Measuring Residential Real Estate Risk and Return” showed over the long-term inflation-adjusted home prices rose less than 1 percent a year. This return does not take into consideration the costs of owning real estate such as property taxes and repairs. The report did note there were a few individual quarters when the S&P Case-Shiller home price index fell. According to Index Fund Advisors (IFA.com), stocks have delivered an average annual return of 6.2% after inflation. But stock prices have had a lot more down quarters. Americans could be confusing risk with volatility.

You may be thinking the results of the poll are not surprising considering the events of 2008-2009. Stocks prices were pounded, as were real estate prices and many people lost money in the market. It would be natural to think fewer investors would want to own stocks. However, when stock prices decline, is it a good time to buy or to sell? Based on the net redemptions of stock mutual funds during 2008-2009, most investors thought it was a good time to sell. Looking back on the past four years we can see it had been a great time to buy. The same could be said for many of the bear markets which have occurred over the past 100 years.

Some investors saving for retirement sold near the bottom of the market in 2009 and made life-altering decisions based on emotion, this loss is very real. They may now be insecure about their financial future and have little confidence in being able to retire at 65. Those investors who stuck to their strategy by holding well-diversified stocks and buying more stocks by rebalancing their portfolios, they most likely will have more confidence in their financial future and retirement plans.

The lesson we should take from this experience is that risk and volatility are different. Volatility is daily, monthly, and annual fluctuations in stocks’ prices. Risk is living longer than your money does and having inflation eat away at the income you have left. Most investors need a healthy dose of stocks to fight off inflation and provide an increasing stream of income. The return on stocks after inflation has handily beaten real estate and bonds over time but with more volatility. Don’t let your retirement dreams fade away by confusing risk and volatility.

Rick’s Insights

  • There is a connection between falling stock ownership and more people feeling insecure about retirement.
  • Buying high and selling low is a terrible investment strategy.
  • Take advantage of stock market volatility by rebalancing your portfolio when the market dips and peaks.

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