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31 May 2011
Fixing Your Money Mistakes: Not Enough Risk
Monday, May 30, 2011, CNN Money
With every financial decision, you have to balance two competing urges: the desire to not be poor and the desire to be rich. Lately the former has been trouncing the latter.
"Probably the biggest shift I am seeing is that clients are solely concerned about their downside," says Adam Sherman of Firstrust Financial Resources in Philadelphia. "And they are all too willing to give up potential upside just to be sure their downside is protected."
Indeed, a recent MFS Investment Management survey of investors found that barely a third consider stocks a good investment these days. The money gathering dust in bank savings accounts and certificates of deposit has ballooned by nearly 20% since 2006.
And over the past two years more than $60 billion has poured into equity-indexed annuities, which dangle a piece of stocks' upside without the risk of losses but are saddled with high commissions and expensive surrender charges.
"Anything with a guarantee," says Sherman, "is white hot."
How it costs you:
Even with today's sub-3% inflation, you can't hope to keep up if your money is earning half a percentage point at the bank. When your portfolio lags inflation, your purchasing power is gradually chipped away.
Over the past 50 years inflation has averaged 4.1%; during that time, large-cap stocks returned an annualized 9.8%.
"As hard as it may be to stick with stocks, given what has happened," says Robert DiQuollo, an investment adviser with Brinton Eaton, a wealth-management firm in Madison, N.J., "history has proved that they have a great record of delivering inflation-beating gains."
Why you do it:
Your memory is short. Stocks fell 57% from late 2007 to early 2009 and lagged bonds for the entire decade. When you decide equities will never be worth the trouble again, you're forgetting stocks' long-term record and assuming that these recent events are the "new normal" — a problem that a quarter of advisers in the MONEY/FPA survey tagged as a common investor mistake.
The near past has a strong influence on your expectations: According to a 2010 study in the Journal of Behavioral Finance, on average the returns that investors forecast after living through a bear market are 1.6 percentage points lower than what bull market alums anticipate.
You've never met a real bull. If you started investing within the past 10 years, you may be even more dubious of stocks' ability to make you rich. A recent study by economists at the University of California at Berkeley and Stanford University looked at how individual investors' appetite for stocks and bonds waxed and waned between 1960 and 2007.
Their conclusion: As a result of the 2008 crash, the willingness of an average 30-year-old to buy stocks will drop seven percentage points; among 60-year-olds who have experienced both bull and bear markets — the expected drop in "stock market participation" will be half that.
How to fix it:
Scare yourself silly. "Investors are stuck on protection of principal when they should be focused on what their principal can do for them," says Colleen O'Brien, a vice president at Charles Schwab. Your principal will be supporting your golf games and travels after you retire, so head to a savings calculator like the one at cnnmoney.com/tools and run the numbers using a cash return of 3%.
That's not the comfortable retirement you were hoping for, right? Now do it again assuming a stock and bond portfolio earning 7%. "When you force yourself to focus on what you want your retirement to look like," says O'Brien, "that helps you get moving toward that goal."
The EBRI Retirement Confidence Survey found that workers who have done some kind of retirement calculation have higher — and more realistic — savings goals than those who have never run the numbers. Plus, 67% of the doers are confident about retirement, vs. 49% of all workers.
But don't be a hero. Do you know what will really turn you off stocks for good? Jumping in with both feet today, just as the market is nearing its pre-crash highs, and then taking another beating on the next dip.
If you're in your thirties or forties and afraid of the market, aim to reach, say, 30% in stocks over the next two years. That's still too conservative for someone your age, but it's a start.
Divide to conquer your fears. Splitting your money into long-term and short-term buckets — the same trick that can stop you from jumping in and out of stocks — can also help you overcome your fear of stocks in the first place. Again, your long-term bucket doesn't have to be filled to the brim with stocks.
Source: Yahoo! Finance
Author: Carla Fried, CNN Money
