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Six ways our brains make bad financial decisions

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Our brains are hard-wired to choose short-term payoff over long-term gain. Duke University professor of psychology and behavior economics Dr. Dan Ariely has a great article on this subject. Here are six common mistakes investors make – and how to avoid them.

SAVING: What’s more important: buying a new iPad nowor saving that moneyfor the future?
RETIREMENT PLANNING: How much money do you think you need for your retirement, assuming you plan on maintaining your current lifestyle?
INSURANCE: Why do we make such bad decisions when it comes to insurance?
SHOPPING: Why do we invest in extended warranties?
MORTGAGES: Why do we buy mortgages from the same old suspects?

Read Dr. Ariely’s article here and learn how to avoid these bad decisions.

Thirty Years Ago Today…

Thirty years ago to this day, the following words were written:

“We do not have, never have had, and never will have an opinion about where the stock market, interest rates or business activity will be a year from now.”

–Warren E. Buffett, the world’s most admired, least imitated investor, in his annual letter to shareholders 30 years, dated February 28, 1989.

Note:

On February 28, 1989, the Standard & Poor’s 500-Stock Index closed at 288.26. Yesterday it closed at 2,792, fairly close to ten times where it was on the day of Mr. Buffett’s letter. Of course, this ignores dividends.
The cash dividend of the S&P 500 for the full year 1989 was $11.73. For the full year 2018, it was $53.61, a bit more than four and a half times where it was in 1989.
To get a sense of how these increases compare to inflation, note that the Consumer Price Index stood at 122 in February 1989. In January 2019 it was 253, having slightly more than doubled in the interim.

When will we ever learn?
It was never about “timing the market.”
It is always about TIME IN THE MARKET.

5 Big Retirement Mistakes

#1 Not paying for financial guidance
People who have no problem paying for the services of an accountant or lawyer often balk at the prospect of cutting a check to pay for investment advice. Instead, they rely on “free” help from retirement advisers they meet at banks, brokerage firms and retirement seminars.

#2 Investing in something you don’t understand
If your financial adviser recommends an investment you can’t explain to someone else, just say no. It will likely carry steep fees (to pay steep commissions) and be less wonderful than it is touted to be.

#3 Supporting your adult children
You might be tempted to help them with a down payment or living expenses, but unless you are certain that you have enough to ensure your own survival, don’t do it.

#4 Low-balling elder-care costs
When planning for retirement, few people think about how much they might end up spending to support elderly parents. Inflation and longevity could erase the purchasing power of the children’s pension and savings, leaving them with too little to live on, let alone cover medical expenses.

#5 Underestimating how much you will need
It is easy to underestimate the impact of inflation and longevity, or the cost of health care, supporting family members or caring for a spouse with Alzheimer’s disease or cancer.

Source: Wall Street Journal

10 Most Common Behavior Biases of Investors

Robert Seawright with Madison Avenue Securities assembled this list of the ten most common behavioral biases that hinder investors:

Confirmation bias – we gather facts and see those facts in a way that supports our pre-conceived conclusions
Optimism bias – our confidence in our judgement is usually greater than our objective accuracy
Loss aversion – the pain of losing $100 is at least twice as impactful as the pleasure of gaining $100 (causes investors to hold onto their losing stocks too long)
Self-serving bias – the good stuff that happens is my doing while the bad stuff is somebody else’s fault
Planning fallacy – overrate our own capacities and exaggerate our abilities to shape the future
Choice paralysis – we are readily paralyzed when there are too many choices
Herding – we run in herds, latching onto the group think and moving in lock step
We Prefer Stories to Analysis – people love a good narrative and prefer to be swept up by the story rather than work through the definitive numbers
Recency bias – we tend to extrapolate recent events into the future indefinitely
Bias blind-spot – the inability to recognize that we suffer from the aforementioned cognitive distortions!

Guessing at Retirement?

Here are some startling facts when it comes to retirement planning:

75% of middle-class Americans say their estimates of their retirement needs are based on “some sort of guess”.
Middle-class American believe the median cost of their out-of-pocket health care in retirement will be $47,000 when the actual number according to the Center for Retirement Research is $260,000.
On average, middle-class American expect to withdraw 10% of their nest egg annually in retirement. Most experts recommend annual withdrawal rates of only 3% to 4%.
34% of middle-class Americans expect to live off of 50% or less of their pre-retirement income. Since the median household income is ~$50,000, these folks are planning on living off of less than $25,000 per year.

Are you playing the guessing game or have you done detailed calculations of your retirement needs?

Source: New York Times

Rich Dad, Poor Dad, Bankrupt Dad?

You’ve probably heard of Robert Kiyosaki through his best-selling book series, Rich Dad, Poor Dad. Kiyosaki holds himself out as a self-made wealth guru who is happy to share the secret money-making strategies of the wealthy.

The tactics that he has advocated range from silly to illegal and include things like insider trading, buying multiple real estate properties for no money down, and buying stocks on margin via unfunded brokerage accounts.

And you can add bankruptcy to Kiyosaki’s highly questionable list of strategies. One of Kiyosaki’s businesses, Rich Global LLC, filed for bankruptcy protection in 2012 after it was ordered to pay a $24 million settlement. Kiyosaki will not be putting any of his personal fortune toward the settlement.

There is no evidence that Rich Dad, the man who allegedly imparted all these money-making secrets to Kiyosaki, ever existed. Nor is there any evidence that Kiyosaki amassed any significant wealth before the publication of Rich Dad, Poor Dad in 1997. Nonetheless, Kiyosaki is now reportedly worth $80 million!

In all likelihood, Kiyosaki did not get wealthy using the schemes he pushes in his books, but through proceeds of his book sales and personal appearances. He got wealthy selling the dream and illusion of get-rich-quick schemes.

source: Forbes

Quick Check: Are Your Retirement Savings On Track?

The two greatest impacts on your retirement savings over time are starting early and saving consistently. Beyond that, how do you know if you’re on track to have enough set aside to retire comfortably? Fidelity Investments recently published convenient “rule of thumb” that provides convenient, age-based targets to help you gauge your progress.

What’s the end game look like?
If you’ve saved eight times your annual salary by your last year of work before retiring, you should have enough money to replace 85% of your annual income for a 25-year period, including social security.

Age-based targets for retirement savings. For example, at age 35 you should have saved one times your annual salary. By age 55 you should have 5 times your salary. Ultimately retire at age 67 with eight times your annual salary set aside in retirement savings.

Here are the key milestones for getting to 8x and beyond:

age 25: start saving for retirement beginning at 6% of annual salary and increasing this by 1% per year until it reaches 12%; employer provides a 3% matching contribution
ages 31-67: setting aside 12% of annual income for retirement savings with an additional 3% matching contribution from the employer
age 35: you should have saved one times your annual salary
age 45: you should have saved three times your annual salary
age 55: you should have saved five times your annual salary
age 67: retire with eight times your annual salary in retirement saves
age 67-92: live off your retirement savings

Recognize that this is a broad guide and each person’s requirements will vary by the specifics of their situation. Nonetheless, this provides a quick and easy reality check.

What if you check your actual retirement savings and you’re coming up short against these targets? Try to increase your retirement contributions to close the gap. Sit down with a financial planner to review your plans and your portfolios to make sure they are optimized for success.

Age-based retirement savings targets for an individual making $100,000 per year.

Source:
Fidelity Outlines Age-Based Savings Guidelines to Help Workers Stay on Track for Retirement

The Investor Sentiment Wheel

How Does the Stock Market Work?

Real Life Adventures by Gary Wise and Lance Aldrich

This cartoon highlights how your behavior as an investor strongly influences your success. Investor behaviors that likely contribute to reducing your returns include:

The tendency for investors to sell underperforming investments and then replace them with others that performed well; a pattern of “buying high,” and “selling low.”
Emotionally driven decisions that may cause trading at inopportune times.
Investment activity motivated by media hype, financial news networks, or televised “experts.”
Poor market timing decisions resulting in missed opportunities.

Avoid being the subject of this cartoon! Great investors throughout history have understood that building long-term wealth requires the ability to control one’s emotions and avoid self-destructive investor behavior.

Who Is Best to Manage Your Money?

As an investor, you are faced with hundreds of decisions on where to get your investment advice. Here’s a nice breakdown between advisors and brokers that can help steer your decision making process.

The infographic below refers to advisors using the acronym “RIAs” which stands for Registered Investment Advisors.

NorthStar Capital Advisors is an RIA. Note that we have no minimum investment requirements so we win Round 4 below as well! We hope this information will help you understand the role that we play in helping our clients.

(Click on the graphic to enlarge for easier reading)

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