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Don’t Let Short-Term Events Disrupt Long-Term Planning

Written by Guest Contributor - 9 Comments

This is a guest post from Darwin’s Finance. If you like what you see here, please consider subscribing to his RSS Feed.

While it’s difficult to overcome the urge to react to unexpected events in our lives, patience and consideration of the facts almost always yields better results than emotional reactions. We encounter this every day, from holding off on hitting that send button on a nasty email you haven’t yet fully digested, to not punching the guy in the face who just said something stupid to your girlfriend.

In retrospect, such instinctive responses that were delivered without considering the full context, the facts and the likely outcomes most often lead to regret and often, financial pain, down the road.

“Storm of the Century”

While the media loves to talk about the “Storm of the Century” every few years to keep eyeballs glued to the set, we actually have had the snowfall of the century this year in many parts of the Northeast.

Well… We have some friends who tend to make rapid, emotional decisions that often have heavy financial implications. Last week, they proclaimed, “We’re moving to California. This snow is ridiculous and we’re not dealing with another winter like this.”

In truth, they probably won’t see another winter like the East Coast has had, but their minds are made up. They’ve already talked their parents into moving out West with them so they can still see the grandkids, and he’s already looking for work.

They’re serious; they’re moving because of snow.

Take a deep breath

Based on my recollections, this winter has been off the charts. In fact, I can recall several winters where we didn’t even have any snow to speak of, perhaps a dusting here or there. So, I looked into it a little further.

As it turns out, we haven’t had this much snow in our region for over 100 years, dating back to when they first started tracking snowfall in 1884. Hmmm… Maybe it was a Storm of the Century. But still… Moving?

What’s the big deal about moving? Well, if snow is the sole catalyst, it just strikes me has highly irrational – and expensive.

An equivalent house (they have a roughly 3,000 sq ft new-construction home) in a reasonably desirable area of California is going to cost more than double what it does here.
California is essentially bankrupt. It’s inevitable that services will be cut while taxes are being raised – and current tax rates are already higher than most states. Is this a place you want to be moving TO? Or running FROM?
Moving costs are not trivial.
What if the job doesn’t work out? It’s tougher to find high paying jobs than it used to be.

It’s now evident this wasn’t a typical snowfall season. Since we haven’t had this much snow in over 100 years, it is unlikely that we’ll see something similar anytime soon. This winter was an outlier, pure and simple.

Wanting to avoid bad winter weather is a lot like the understandable, yet irrational feeling of not wanting to drive a car again after a bad car accident, or even people that are afraid to fly even though the trip to the airport is more hazardous than the plane flight itself. While disasters do occur, they are extremely rare, and repeat events of similar magnitude are nearly non-existent.

So, if there’s a once per hundred year earthquake on the fault line which causes damage and fear, will our friends turn around and move back East? This business of reacting to rare events can get pretty expensive!

Investment decisions

This brings me to how similar thinking affects investors. Left to their own devices, millions of retail investors damage their prospects for an optimal retirement asset allocation by constantly tinkering with it. In the midst of the financial crisis, friend after friend proclaimed that they were boldly moving all their money out of stocks and into bonds – Treasury Bonds that is.

Many retirement accounts offer some sort of “conservative” bond fund, and tons of people have flocked into such investments. Not only did most of these people exit at the worst possible time – pivot bottom in March 2009, but they then shifted money into a money-losing Treasury fund while stocks rallied over 60% from their lows in less than a year (compare Mar 9 onward)!

If you thought Treasuries could never lose money, think again. With yields so low that investors were actually taking a negative yield just to stay liquid in short term paper, the only direction for Treasuries to move was down (driving yield up). And they did. It was so plainly obvious to me in 2009 that I shorted Treasuries in my trading account with a practical risk-free gain in my book.

So, what you have here is people that initially had a reasonable asset allocation suited to their risk tolerance and time horizon (often 20-30 years from now!) shifting money around at the worst possible time. By deviating from a long-term strategy with short term reactive measures, their nest egg at retirement could be hundreds of thousands of dollars short.

While stocks make people nervous, no responsible financial adviser would propose a 0% stock allocation and 100% Treasury bond allocation for a 30 year time horizon. History has demonstrated that you’re lucky if you even beat inflation over decades long periods of time in Treasuries, while equities always outperform other conventional asset classes over long time periods.

Regardless of what your long term strategy is – be it asset allocation in your 401K, career moves, altering a small business strategy, or whatever the situation may be – before you “go with your gut” and make a major decision based on a single data point, your emotions, or a perceived reality, make sure you consider the context and what the possible long-term implications are.

What are some of the worst “Gut Reaction” moves you’ve seen?

Published on March 8th, 2010 - 9 Comments
Filed under: Saving & Investing

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9 Responses to “Don’t Let Short-Term Events Disrupt Long-Term Planning”

1
Eric Says:
March 8th, 2010 at 7:03 am
As a Californian, I am offended at your mockery, but I will forgive since you guys did have the sorriest winter I could ever imagine.
2
Michael Harr @ Wealth...Uncomplicated Says:
March 8th, 2010 at 7:08 am
Over the years, I’ve seen investors make bad decision after bad decision. As an advisor, my job was to keep these reactionary moves in check which was easy when the market wasn’t moving much. However, when the market did move significantly up or down, bad ideas were everywhere – load up on asset X because it’s HOT or sell asset Y because it’s getting crushed.

Well, as all experienced investors know, that’s a bad idea as you have pointed out. Fidelity Investments’ research arm had a nice white paper they produced that illustrated fund flows and estimated losses of wealth during major moves up and down in the market. What they found was investors consistently moved money to the wrong side of the market.

I don’t have the exact numbers, but during the Dot Bomb, investors lost an average of 40% (keep in mind that many value stocks were positive or only slightly negative during this time). This was coupled with a move to bonds during the rebound that had them miss another 40%.

In your post you say it’s expensive. Hell yes it’s expensive.

Also, while it’s clear investors are still favoring bonds, it’s important to note that they were overpositioned in stocks ahead of the crash. Part of this money moving into bonds should stay there permanently, but obviously it’s been overdone.

The key to any successful investment strategy is not in finding the greatest return, but in finding the greatest return possible, given your individual risk tolerance.

If you’re an investor that panicked and fled to bonds, take a look at what you were doing before the crash, then look at where your assets are positioned today. The reality is that your portfolio was too risky before and likely not risky enough today. In short, look at the differences and try to find a happy medium that will allow you to stay invested when the next market decline happens.
3
Darwin's Finance Says:
March 8th, 2010 at 8:02 am
Eric, that was a great comment; thanks for starting it off with some levity – our winter WAS horrendous. I guess no particular state’s in good shape. Ours is shutting down national parks after all. Our friends in NJ are getting laid off from public schools which used to be “protected”. Budgets everywhere are a mess; I guess it’s a matter of “how bad”.

Michael, you’re right, I’ve seen study after study demonstrating how retail investors get it wrong most of the time. By doing nothing to allocation, most of us would be much better off.
4
Alissa Says:
March 8th, 2010 at 10:21 am
You might be interested in this TED talk on the comparison between what we actually remember vs what our experiences are:
http://www.ted.com/talks/danie.....emory.html
I think it speaks directly to this and shows that what people think they have experienced as memory isn’t always what actually happened.
5
Dan Says:
March 8th, 2010 at 10:59 am
To the original author:

If your friends are afraid of natural events, remind them that California is home to earthquakes, wildfires, and flooding.
6
Floridian Says:
March 8th, 2010 at 5:33 pm
I’m hurt they didn’t choose Florida We did experience the coldest winter in over 30 years, but still no snow! Oh yeah, we’ve got Hurricanes….but at least you get a good warning with hurricanes. You get NO warning with Earthquakes!

Serioulsy though. Please tell me you made all that up about your friends wanting to move b/c of one cold winter. I find it hard to believe that there are people THAT stupid in this world! oh wait, no I don’t…look at who we have in the White House!
7
John Says:
March 8th, 2010 at 6:07 pm
I have a friend that lost her job last year. I heard about it and went to see her about a week later to see how she was doing. Apparently I was too late. She had begun procedures to take a short sale on her condo, cashed out her 401(k) in order to pay off credit cards, and was not really talking about other job opportunities at the time.

I can see taking the short sale or at least finding out the details, but the 401(k) was the only thing she had which was completely protected. When I asked why she wanted to cash out the 401(k), she argued about it for a short time but then told me it was already done, probably because she could not defend her position.
8
Bucksome Boomer Says:
March 9th, 2010 at 6:23 pm
California is not that bad! Now that the defense of my home state is out of the way, I agree with your point. Don’t make life-altering decisions too lightly.

I hope it works out for the friend; but there are problems no matter where you live. Here it’s threats of fire and mudslides (let alone earthquakes).
9
The Biz of Life Says:
March 9th, 2010 at 9:10 pm
Treasuries and Munis are very risky right now, yet investors have flocked to them because of the financial. Treasuries are in a bubble, where the government has artificially manipulated the yields to historic lows. Interest rates can only go up as the financial and monetary stimulus is withdrawn, which means investors will lose principal. State and local governments are facing dramatically reduced revenues due to drops in employment and falling real estate prices. Muni bonds that are most at risk are issues by states and municipalities in CA, NV, FL, IL (I’m sure I’ve let out a few). Right now I’d rather get my yield from stocks than bonds. As economic activity picks up interest rates will rise as business conditions improve.

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