by Joe Hearn | Dec 20, 2011 | Investing, Retirement, Risk
So far during 2011, the Dow Jones Industrial Average has had moves of 100 points or more on 97 trading days. That’s 23 more than during all of 2010 and the year isn’t even over yet. With so much volatility and uncertainty, it would be easy to panic and make decisions you’ll later regret. Unfortunately, your mind isn’t always wired to help. In fact, it can actively work against you. Below are seven cognitive biases that could cause you to make bad investment or retirement planning decisions, as well as suggestions for overcoming them.
Attention bias
This is the tendency for emotionally dominant stimuli to monopolize our attention. CNBC, I’m looking at you. Spending too much time watching the ups and downs in the market is likely to fray your nerves and cause you to sell low and buy high. Remember the words of Warren Buffett: “The market exists to serve you, not instruct you.”
Bandwagon effect
This one is pretty self explanatory and was the primary driver in such spectacular failures as the internet, telecommunication and housing bubbles. When trades get completely one-sided (gold?), it’s time to ask yourself if you’re just buying or selling because that’s what everyone else is doing.
Action bias
In times of stress or danger, it sometimes makes us feel better to act, even if it would be better for us to sit on our hands. A great example I heard of this recently relates to soccer. During a penalty kick the ball is kicked to the center of the net 30 percent of the time, but the goalie only stays put 6 percent of the time because he doesn’t want to look like he’s not trying. Sometimes the best thing you can do is nothing.
Recency bias
This is our tendency to give more weight to recent events than past events. The 2008 global financial meltdown is still pretty fresh in everyone’s mind. Eager to avoid a repeat, many are ready to move to the sidelines at a moments notice. Keep in mind, though, that during the lifetime of the baby-boomers, the S&P 500 has gone from about 17 to 1,250. That’s 73 times higher now than when the first baby-boomer was born. Don’t let the emotion of recent headlines completely overshadow the historical record.
Hyperbolic discounting
This is our tendency for immediate gratification at the expense of the future. In a nutshell, Current You doesn’t care much for Future You. Current You wants to stop making 401(k) contributions and put the money under the mattress so he can sleep better at night. Future You needs that money saved and invested so he can afford to retire. If you want Future You to be happy, you need to convince Current You to make some decisions that are uncomfortable.
Negativity bias
This is our tendency to give greater weight to negative information over positive. Yes, there are a lot of things wrong with the world, but there is a lot that is right. Pick any vintage from the wine cellar of history and you’re likely to find some sort of man-made or natural disaster. And yet, the economic and technological progress we’ve made over the last many decades is amazing. Admittedly, it sometimes feels like a yo-yo, but if you step back you can see that the general progression has been up and to the right.
Illusion of control
Finally, we arrive at our tendency to assume that we have more control over events than we actually do. None of us can control the debt crisis in Europe, but we can control our personal debt. We have little influence over Washington’s spending, but we can make sure our own budgets are in order. Few of us have the ear of the Social Security commissioner, but all of us can make sure that our own retirement investments are allocated properly and that we have a logical distribution strategy. In short, focus on those things you can control.
Will Rogers once said “It’s not what you don’t know that hurts you. It’s what you know that isn’t so.” The way our brains are wired, as well as the ups and downs in the markets during the last few years, have caused many to make regrettable decisions based on “what they know that isn’t so.” Hopefully understanding your brain’s natural tendencies can help you make better long-term decisions that result in a secure, meaningful retirement.
Thanks for reading. If you enjoyed this article, scan the “Related Posts” section below for others like it.
Joe
by Joe Hearn | Dec 16, 2011 | Income, Investing, Retirement
“You’re going to die in 48 hours.” If a doctor gave you that diagnosis, would your plans change for the next two days? Absolutely, right? You would be racing around like a madman (or woman) saying goodbye to family and friends and tying up as many loose ends as possible.
Now imagine that the diagnosis changed from 48 hours to 48 years. My guess is that your sense of urgency just evaporated. No need to rush. There’s plenty of time to live life, spend time with family and work through your “To do” list. That’s because for most things, time and urgency or inversely correlated. That’s just a fancy way of saying that a whole lot of time equals not much urgency and vice versa.
That equation is true in sports, life, deadlines at the office and just about everything else you can think of. Where it doesn’t always hold true, however, is with your money, where less time often translates into less urgency. Given 48 hours to live, I’m guessing money would be the last thing on your mind. You certainly wouldn’t swing by the HR department and increase your monthly 401(k) contributions. But that is exactly the kind of response you should have after learning that you have 48 years to live. The more time you have (i.e. the longer your life expectancy), the more money you will need and the more urgent it becomes to be saving as much as possible. So if you plan on living for awhile, hurry up! You have a lot of time and there isn’t a minute to waste.
A few practical applications:
- Automate your savings in 2012 by having money automatically taken from your paycheck or checking account each month.
- Calculate what you saved this year and increase it by 1% next year. If possible, do the same every year after.
- If older than 50, take advantage of the catch-up contributions allowed on your 401(k) and IRA.
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by Joe Hearn | Dec 13, 2011 | Pursuits, Retirement, Travel
I received an email the other day from a friend who had just finished reading an article of mine in the newspaper. His email said:
“I awoke this morning feeling at peace with my future; thinking I had everything under control and that my family’s needs were completely taken care of. Then I read your article. I broke out into a frantic sweat and [expletive deleted] my pants. Thanks a lot for the reality check. Much like the rest of America I prefer to operate in a delusional universe where I don’t need to think about those things.”
I’m not going to lie to you; I laughed pretty hard at that. But his point was a good one. Sometimes the coverage devoted to retirement planning can seem kind of negative (either by design to draw attention or simply because the reader feels convicted).
Because of that, it’s easy to lose site of all the things that are right with the world, great about retirement and amazing about the opportunities available to each of us. So as penance to my friend and as a reminder to us all, I give you some reasons to look at the glass as half full.
Peace, love and understanding
According to Harvard Professor Steven Pinker, we’re living during the most peaceful time in our species’ existence. Yes, we still have wars (I suspect those will always be with us), but the average number of violent deaths per 100,000 people has dropped from 15 percent during prehistoric times, to 3 percent during the 20th century, to a fraction of 1 percent now. True, I have sometimes felt nervous on the subway when traveling in a strange city, but at least I don’t have to worry about being thrown to the lions in the Coliseum or being used in an elaborate human sacrifice to appease the volcano god.
Medicine and life expectancy
I take Lipitor to lower my cholesterol and reduce my risk of heart disease. My sister had a cancerous tumor the size of a grapefruit in her neck, but after treatment she has been cancer free for years. My grandfather was cutting firewood when a tree fell on him and shattered his hip. His doctors replaced it with a new one made out of titanium and he’s been getting around great for the last decade. Modern medicine has been enormously successful at increasing both the quantity and quality of our lives. As life expectancy has increased, retirement has changed dramatically. Rather than being a time to wind down, it is now viewed as a new chapter in life that is active and can last for decades. Be thankful for your health and use all that extra time wisely.
Technology
If asked, I would have to put my iPad in the same category as such worthwhile inventions as the wheel, penicillin and the printing press. That might be a bit of an overstatement, but you get my point: Technology is pretty remarkable. More than just cool, however, it is useful and helps us live fuller, more productive lives. It’s hard to imagine life without things like computers, the Internet, email, cell phones, digital cameras, ATM machines, MRIs, global positioning satellites, iPads, iPods, Kindles, and cloud computing. The other night our daughter was using FaceTime to video chat with her grandparents in Alaska. That’s the kind of invention that was imagined for the 23rd century in old Star Trek episodes! After looking at how technology has advanced in the last 30 years, imagine what the next 30 years will look like (especially since the pace of advancement is accelerating). It should be pretty amazing.
Learning
All that technology has greatly expanded our avenues for learning. Gone are the days when you need to spend $100,000 and four years of your life just to learn about something you’re interested in. With iTunesU you can sit in on history classes at Oxford or take photography classes from National Geographic (all free). Search engines like Google can answer any question you put to it. You can bring subjects into focus with Squidoo. Wikipedia can give you a basic understanding of almost anything. You can take guitar lessons on You Tube, learn to simplify your life on Zen Habits, or learn how to mix a martini like James Bond (or any number of other things) on Expert Enough. With so many resources, it’s easy to channel your inner Jefferson and make learning a broad and lifelong endeavor.
Social interaction
Yes, there are negatives to sites like Facebook and Twitter, but used properly they do an amazing job at connecting you to the people you care about. Social interaction is a critical element to human happiness and we have more ways than ever to experience community and connect with friends and family.
Doing good
Even with everything that is right with the world, there is still a lot that is wrong. Thankfully, there are some amazing people trying to do something about that and they’re looking for people like you and me to jump in and help. Charity is no longer limited to just writing a check or dropping a few bucks in the offering plate. Volunteering locally or getting involved with organizations like charity: water, International Justice Mission, and World Vision allow us to reach beyond ourselves and do work that not only helps others, but gives us a deep sense of satisfaction, fulfillment and purpose.
Traveling the world
There hasn’t been a more exciting time in travel since Kitty Hawk. The triumvirate of jetliners, online travel resources, and countries clamoring for tourist dollars have combined to make global travel accessible to almost anyone. A hundred years ago, most people lived their entire lives within walking distance of their house. Now you can hop on a plane and be hiking in the Andes or walking down the Champs Elysees by breakfast. For a little inspiration visit Everything Everywhere or Lonely Planet. And don’t let money hold you back. There are sites like travelhacking.org that can teach you how to search out deals and rack up frequent flyer miles. Then you can spend those miles on a round-the-world plane ticket and take off in search of adventure. As Saint Augustine said, “The World is a book, and those who do not travel read only a page.”
Well, there you have it. While certainly not a complete list, I’ve given you a few reasons to look on the bright side. Sure, there are still a lot of people unemployed, the housing market is still a mess and the stock market is just as bipolar as ever, but resist the temptation to focus on the negative. It sounds trite, but you only live once. None of us should let fear and uncertainty keep us from pursuing our dreams or living a rewarding and meaningful life. To paraphrase Oliver Wendell Holmes, don’t die with your music still inside you. Look at the glass as half full and live a life you can be proud of.
Thanks for reading. Have a great week!
Joe
by Joe Hearn | Dec 9, 2011 | Pursuits
I saw a great post today by Tyler Tervooren at Advanced Riskology. I thought it was timely inspiration as you work on your plan for the New Year, so I asked him if I could share it with you (see below). Hope you enjoy it. Check out Tyler’s website for more “get out of your comfort zone” goodness. Have a great weekend!
Joe
How to run 26 miles
How to run 26 miles: run 25.
How to run 25 miles: run 24.
How to run 24 miles: run 23.
How to run 23 miles: run 22.
How to run 22 miles: run 21.
How to run 21 miles: run 20.
How to run 20 miles: run 19.
How to run 19 miles: run 18.
How to run 18 miles: run 17.
How to run 17 miles: run 16.
How to run 16 miles: run 15.
How to run 15 miles: run 14.
How to run 14 miles: run 13.
How to run 13 miles: run 12.
How to run 12 miles: run 11.
How to run 11 miles: run 10.
How to run 10 miles: run 9.
How to run 9 miles: run 8.
How to run 8 miles: run 7.
How to run 7 miles: run 6.
How to run 6 miles: run 5.
How to run 5 miles: run 4.
How to run 4 miles: run 3.
How to run 3 miles: run 2.
How to run 2 miles: run 1.
How to run 1 mile: Walk out the door.
How to walk out the door: Put your shoes on and stand up.
How to put your shoes and stand up: Get off the couch.
How to get off the couch: Have some respect for yourself.
How to have some respect for yourself: Decide that you’re worth the effort.
Milestones.
by Joe Hearn | Dec 6, 2011 | Social Security
If you’re like most, you know what Social Security is, but you’re a little hazy on the details. Don’t feel bad. There are 78 million others in the same boat. Retirement is on the horizon, though, so it’s time to bring you up to speed. Give me 10 minutes and I’ll give you answers to the 10 most frequently asked Social Security questions.
Q: Is Social Security enough to live on?
A: I won’t say it’s impossible, but it’s not easy. For 2011, the maximum monthly benefit for a person retiring at full retirement age (66) is $2,366. That assumes you earned the maximum taxable amount of income every single year after turning 21. Not many people are in that category. In fact, the average monthly payment was $1,177 for 2010. Multiply that times 12 and you’re officially below the poverty line. Social Security is a great way to supplement your income, but being totally reliant on it is not a retirement plan. In all likelihood it means that your retirement planning has failed.
Q: Can I count on Social Security?
A: Those at or near retirement will probably receive most (if not all) of what was promised. Those with a long ways to go probably won’t be so lucky. Why? Social Security is a self-financed program that uses tax dollars from current workers to pay the benefits of current retirees. In 1945 there were 40 workers for every person collecting benefits. Now there are about 3 workers for every retiree. High unemployment and a wave of retiring baby boomers have put further strain on the program.
Benefits being paid already exceed tax revenues collected and in their 2011 report, the Social Security Board of Trustees estimated that the program will only be able to pay promised benefits through 2036 (one year earlier than previously estimated). At that point the Social Security trust fund will be exhausted and revenue from workers will only be able to pay about 75 percent of promised benefits. Expect taxes to be raised and benefits to be cut long before we get to that point.
Q: When can I begin collecting benefits?
A: If you are eligible to receive Social Security benefits, you can begin collecting reduced benefits as early as age sixty-two. Most people (all 78 million baby boomers included) will need to be on the downhill slide to seventy before becoming eligible for full benefits. Click here to see a detailed chart of full retirement ages.
Q: What if I retire early or late?
A: Retire early and your benefits will be permanently reduced. Retire late and they will be increased. How much depends on how early or late in relation to your full retirement age. Retire up to 36 months early and your benefits will be reduced by 5/9ths of 1 percent per month. Anything over 36 months results in a 5/12ths of 1 percent reduction per month. For example, if your full retirement age is 66 years and 8 months and you retire at 62 (56 months early), then you can expect an almost 30 percent reduction in benefits.
Those retiring late get a credit for each year they wait. If you were born after 1943, the credit is 8 percent per year and it is paid to a maximum age of 70. For example, if your full retirement age is 67 and you retire when you’re 70, then you will have a 24 percent permanent increase in your monthly benefits.
Q: Will my benefits be subject to tax?
A: Maybe. If you have income sources in addition to Social Security, you may need to pay taxes on a portion of your benefits. If your modified adjusted gross income (MAGI) plus half of your Social Security benefits exceed a certain amount ($34,000 if you’re a single filer and $44,000 if you’re a joint filer), you will likely need to pay taxes on 85 percent of your Social Security benefits. If your MAGI is less than that, but still more than $25,000 for single files or $32,000 for joint filers, then you may need to pay taxes on 50 percent of your benefits. For further information on taxation of Social Security benefits, see IRS Publications 554 or 915. Tax law is complicated and subject to change, so always consult a trusted tax adviser.
Q: Will continuing to work affect my benefits?
A: You can work while collecting benefits, but if you haven’t reached full retirement age, your benefits will likely be reduced. I say likely because you are allowed to earn a certain amount of income before they begin docking your benefits. For 2011, the earnings limit is $14,160. If you are under full retirement age, your benefits will be reduced $1 for every $2 you earn above that limit. In the year you reach full retirement age, the penalty will be reduced to $1 for every $3 of earnings and the earnings limit will be increased. Once you reach full retirement age, you are free to earn as much as you want with no reduction in benefits. Also, the earnings test reduction is not permanent. At full retirement age your benefits will be increased to compensate for the benefits withheld because of your earned income.
Q: How do spousal or family benefits work?
A: Others in your family may be entitled to receive Social Security benefits based on your earnings history. This could include a spouse, former spouse of at least 10 years, disabled children, unmarried children under age 18, or children under 19 who are full-time students. These benefits are in addition to the benefits that you are entitled to and could be worth as much as 50 percent of your benefit for each person who qualifies. Each family has a maximum benefit that they can receive, however, which is roughly equivalent to 150 to 180 percent of your full retirement benefit. If this amount is exceeded, your benefits won’t be affected, but everyone receiving benefits based on your work history will see their benefits reduced proportionately.
Q: How can I get an estimate for my Social Security benefits?
A: Unfortunately, the Social Security Administration no longer sends out annual statements that show a record of your earnings and accumulated benefits. You can still estimate your benefits, but it will take a little work. Go to http://www.ssa.gov/ and click on “Estimate Your Retirement Benefits.” Begin by entering your name, Social Security number, date of birth, place of birth, and mother’s maiden name. If that information matches what they have on file, you will be able to use the estimator to enter your planned retirement date and expected future wages. That information is then combined with your past earnings history (already on file with SSA) to generate a reliable estimate of your expected future benefits.
Q: How do I apply for benefits?
A: You can apply online at http://www.ssa.gov/ using the Internet Social Security Benefit Application. You can also apply by phone, mail, or in person at any Social Security office. To cut down on your wait time, it’s recommended that you call 1-800-772-1213 (TTY 1-800-325-0778) to make an appointment. You will need certain documents to apply, such as your birth certificate, naturalization papers, U.S. Military discharge papers, and/or W-2 forms (or self employment tax returns if applicable) for last year.
Q: When should I file for benefits?
A: You basically have four choices. You can file early, file on time, delay filing to accrue increased benefits, or file and suspend. If you are married, your spouse has the same options. Most want to maximize the benefits they receive, so it makes sense to choose the option or combination of options that result in the greatest cash flow for you and your family. In the interest of space, I’ll leave it at that for now. In a future post I’ll talk much more in depth about how to maximize benefits and decide which option is best for you and your family.
Well, those are the 10 most frequently asked Social Security questions. If you have a question that I didn’t answer, touch base with me and I’ll do my best to help. Thanks for reading!
Joe
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