As most people near retirement – or at least start to dream about it – they begin to ask themselves questions that they have probably been avoiding or pushing off for years.

Do I have enough?

When should I take my pension or social security?

Can we afford to go somewhere different during the winter months?

What should I anticipate healthcare costs to be?

All of these questions lay the foundation for one of the most important decisions you will make in your lifetime – when to retire.  The last thing you will want to do is retire and figure out the answer to these questions afterwards.  That could be very scary and stressful.  After all, retirement is supposed to be stress-free and enjoyable – at least that is what all the commercials say!  So how do you prepare yourself to for that next chapter in your life?  It is very simple; it is to build a Financial Plan.  This is the first post of a many dedicated to the importance of having a financial plan.

According to Princeton Survey Research, 69% of retirees have not done a comprehensive financial plan to prepare themselves for retirement.  WOW!  This blows me away.  Many people have worked all their lives to prepare themselves for this new journey, yet most are not willing to put in the time to make sure they will have enough money, will they run out of money or how do they distribute their assets in the most effective way.  Imagine someone told you to get in your car and drive to Mexico without a map, directions or signs – could you do it?  Possibly, however, you probably had a few bad decisions or wrong turns along the way and hopefully you did not run out of money for gas.

The point I am trying to make is very simple –  many of you could make it through retirement without a financial plan and not run out of money, however, you probably could have done a few things smarter and potentially with less risk.  The question you all need to ask yourself is – am I willing to put in a minimal amount of time and effort to work with someone to develop a financial plan that helps my family live smarter in retirement?  I hope most of you answer yes!

Let’s cut to the chase and talk about specifically what a financial plan can do for you.  Oftentimes, the biggest misconception about a plan is that it is just a basic income projection to determine if you will run out of money or not.  Many plans will use unrealistic assumptions like returning 6% year after year. A financial plan is a working document that serves a map to point you in the right direction as you proceed through life.  A good financial plan should be proactive and present future roadblocks before you hit them.  Things like taxes, income needs, rate of return and risk all change over time.  Being able to update and see how all these variables affect your plan is the true value in having one.

In my experience most people do not want to know how much money they can leave to their beneficiaries – they want to know how much risk they have to take so they can live through their retirement without unnecessary risk and volatility.  Imagine if there was a strategy to distribute your assets with while paying less taxes or maximizing the total amount of Social Security between you and your spouse.  This is what a financial plan does.  You are able to look at all possible variables to determine how they all affect each other and see which the smartest decision for you going forward is.

Financial plans can also provide additional advantages for people planning for retirement that have nothing to do with money but everything to do with our emotions.  Going through the exercise to develop a plan is fantastic; however, sticking with it becomes the difficult part – especially when we become emotional.

We as humans are creatures of habit and all have similar traits in some respects.  When it comes to behavior and emotions, oftentimes this is even truer.  Our emotions swing from being really excited and overly optimistic when something great happens to depressed and lethargic when things do not go our way.  Our emotions cause us to veer off the trail of our financial plan when things do not go exactly according to plan.

Financial planning is a process or a working document, once it is completed you do not leave it on the shelf to collect dust.  It needs to be reviewed annually to assure you are still on the right track, but more importantly, you need to stick with it.  Emotionally this is tough to due.  I am going to talk briefly about a few common behaviors that the typical person encounters when making financial decisions.

Following the Crowd

“So and so said to buy xyz stock because his cousin has owned it and made a bunch of money.”

“They said the market is going to going to crash.”

These are comments I hear all the time and my first response is usually, “Who is They?”

Following the crowd is usually precedes a market crash.  In the late 90s, everyone was telling everyone to buy technology stocks.  In the middle 2000s, everyone was borrowing as much money as they could so buy real estate.  From a behavioral standpoint, the same mistakes were made.  People were following the crowd without looking at their financial plan or having a basic strategy of how they were going to handle these particular investments based on a good or bad outcome.  Neither situation turned out well for those who invested in these times without a basic plan.

As you plan for retirement, you need to determine the amount of risk you need to take as a family to achieve your goals and not follow the actions of others.  The last thing someone needs to do prior to retirement is take unnecessary risk.  Proper planning will help you determine your risk tolerance so you know what investments are suitable for your situation.  Even if you do want to follow the crowd on a specific idea, a plan would at least help you determine how much you can afford to risk or lose.

Fear and Greed

When markets go up you become over confident and think the markets will continue to go up.  It is almost like feeling invincible.  Then when the markets go down we get scared and don’t want to lose our money.  Buying high and selling low is not a viable investment strategy.  This behavior alone is the main reason investors should have a well-defined risk tolerance and asset allocation strategy so they are able to stick with their investments during all market conditions.  A financial plan helps you avoid this demon from destructing your wealth because you have written investment policy for your money.  According to Dalbar and Associates, the average investor returns less than have the S&P 500 over the last 20 years.  This behavior mistake has been the primary reason for that.

Confirmation bias

This is simply finding or believing information that supports your opinion.  If you think the markets are going to do down, you will only look for or read information that confirms your preconceived opinion that the markets are going to go down.  You must take an unbiased approach to investing or will get caught taking too much risk believing your opinion.  The media does a fantastic job of manipulating our minds when it comes to confirmation bias.  I’ll touch on media in a second.

Hindsight

“I saw this crash coming in 2008 and wish I would have sold.”

“If I only would have put more money in that stock I would be rich and retired.”

If I had a nickel for everything I have heard that I would be retired!!  This is a thought that is unavoidable and we all have experienced.  We can’t dwell on the past, only focus on the future.  Use your energy and efforts to help improve future results.  The past is only the past.

Media

At some point I will do a whole post on the affects media has on investors.  To be brief for this post, keep in mind that the media does not have your best interest at heart.  Their job is not to help you make more money or take less risk; their job is to sell advertising.  They use all these behavior finance mistakes against you to increase their ratings.  Little is done to hold media accountable to what they say or do.  Although media can provide some guidance from time to time, rarely is it specific to one person or group.  Follow your financial plan, not the media.

I have just wrote about how emotions that can ruin a person’s retirement if they do not harness their behaviors appropriately.  A financial plan alone will help you elevate some of these mistakes assuming your follow your plan.  This is where a Financial Advisor can help.  A good Financial Advisor should not only help you create your plan, but make sure you do not fall victim to your own demons and see that plan through.  One emotional lapse could wreck years of hard work.  Proper advice and guidance should shepherd you those emotional times and keep you focused on the end goal.

Hopefully I have driven home my point to everyone.  I am very passionate about this topic.  Please take the time to plan for you and your families’ future as there is really no excuse not to.

Matt Gulbransen, AWMA, is a Financial Planner in the Minneapolis/St. Paul metro area.  He works with pre-retirees and retirees to help prepare them for retirement.  He has offices in Woodbury and Apple Valley, MN.

As many of know, I have transitioned my firm over the past year.  I am now a Partner with Callahan Financial Planning.  One of my goals for this year was to increase my activity on this blog to provide better content.  Look for more content as the year goes on.  Make 2014 a great year!

Matt

As investors we oftentimes find ourselves using the Dow Jones or S& P 500 as the comparative index in order to determine if our portfolio is sufficient. This is just fine if you are someone who has a substantial time horizon or is purely focused on growth. However, most people I work with (baby boomer and older) are typically not in this scenario. Most investors that are nearing or in retirement should be more focused on what return they need to make in order to maintain the retirement goals or lifestyle they desire. More importantly, stay focused on protecting your capital.

Let me give you all an example. Let’s say you have done some income planning and determine that you need 6% annually in order to have enough money to live off of until age 95. Knowing that, why would this type of investor want to be fully invested in a S & P 500 like portfolio in the uncertain economic times we are in today? The answer is that they would not. As investors we always have to ask ourselves, “Am I taking the appropriate amount of risk for the return I need?”

In doing many reviews and meeting with clients and potential clients recently, I have noticed that many people feel they are missing the bus or are concerned that they are not maximizing their return in the markets. This is the same type of behavior that got people in trouble in 2008. Looking back, many investors have admitted that they we probably were taking too much risk then. Yes, 2012 has produced great returns, however, look at the amount of economic and political risk that has been occurring during this time period.

At the end of the day, we all have to remember to keep our emotions in check. Fear and greed is the root of evil when it comes to investing. It is my beliefs that if you focus more on what return you need in order to achieve your goals it will be much easier to manage risk, but more importantly manage your emotions when the markets make you start to get greedy or fearful.

Creating your own family or personal index may be the best solution to keep you on track.

Hope this helps. Enjoy your day.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.  You can not invest directly in an index.

Over the past few years, the markets have reacted very strong after the Federal Reserve has announced or implemented additional strategies to help the American economy.  What you see and read is oftentimes difficult to understand.  I want to clear this up and hopefully give you a better understanding of what the Fed is up too.

Below you see a chart of the S & P 500, 10-year U.S. Treasury yields and Fed Funds rate going back to 2007.  The green shaded areas represent action taken by the Federal Reserve.  In these examples we had Quantitative easing, QE2 and Operation Twist.  Let me explain what is trying to be accomplished by this:

Quantitative easing:  Being that interest rates were already low, the Fed needed to take additional measures.  Quantitative easing is where our Central banks go out and buy treasuries or other government securities.  By doing this, they are flooding the financial institutions (banks) with capital.  This now makes them more willing to lend money.  Remember all those bad investments banks made… they needed capital.  The risk with this is that more money needed to be printed in order to do this.  When there is more money that means future inflation.  This is a major headwind.

QE2:  This is basically the same story.  The Fed created $600 billion out of thin air in order to go out and buy securities.  Another way to look at this is the Fed buys securities in the open market, paying with a government “check.” (That’s how the money is created.) The sellers deposit those checks into their banks. The banks redeploy those deposits as loans to consumers and business. The supply of money is increased, hopefully the economy follows.

Operation Twist:  This may sound like a children’s game, but what the Fed is trying to accomplish here is keeping interest rates low.  By keeping rates low, this will encourage people to buy homes, borrow money for their business or go out and borrow money for personal items.  The Federal Reserve is selling short term government securities ( less than 2 years maturity) and then buying 10-year Treasuries.  Many interest rate products like mortgages are tied to the 10-year Treasury.

I hope this shed some light on what is going.  Based on the chart below, it has thus far.  As I stated, the major problem is when the Fed will start to try and unwind all the debt they have purchased.  There is no defined date of this, but we will know for sure when this starts to happen. 

Hope this was helpful!

Sources: www.ritholtz.com and www.dshort.com

Disclosure: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  To determine which invest(s) may be appropriate for you, consult your financial advisor prior to investing.  All performance referenced is historical and is no guarantee of future results.

Some of you have attended presentations I have done entitled, Smarter than Wall Street. In this presentation, I talk about 4 myths of investing and 5 steps to manage your money like endowments. I will do a few posts on what to take away from this presentation, but today I am going to talk about emotions and investing. Everyone has heard or been told not to get emotionally attached to investing because then you do not make rational decisions… Easier said than done.

Media realizes this. They know that people make decisions based on fear and greed, and that is what sells advertising for them. When the markets are going up you will hear them talking about what is the hottest investment or how people should continue to buy. When the markets are going down, you will hear media talk about how the markets will continue to go down and give off a fearful message.

It is important to keep in mind that there is no one out there who holds financial media accountable to what they predict. If you tune in to CNBC, you will see guests make a variety of predictions. If you make enough predictions, someone will eventually be right.

As investors, we need to tune out this noise and have a plan in place to manage our investment objectively. I stress having a plan to clients. By having a plan, when your emotions get the best of you and you want to make an investment that may not be in your best interest you can refer back to that plan to keep you on track.

I hope that this post helps. As always, please give me your feedback on what you think of my blog. If you know of any friends, family or acquaintances that would benefit from this blog please let me know and I will put them on the distribution list. Cheers!

Disclosure: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which invest(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.