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Investing for 30 years of unemployment we call “retirement”

Investing for one’s retirement is a rather daunting challenge. For most folks, investing during the retirement years is a time when capital preservation seems to be of paramount importance and becomes the driving force behind their asset allocation. The result often times is an allocation to fixed income or bonds that will not stand up to the devastating impact inflation is likely to have on their purchasing power over time.

Perhaps the best illustration of what inflation can do to the cost of living is to look at the cost of a US Postal stamp 30 years ago relative to the cost of the same stamp today. 30 years ago you could buy a stamp and mail a letter for 18 cents. The same stamp today would cost 44 cents. Do the math and you will see that is a 144 percent increase. Because of the likely impact of inflation, preservation of purchasing power should be the driving force for asset allocation — not preservation of capital. This most likely would require a greater allocation to equities as opposed to fixed income and bonds.

The problem with a larger allocation to equities is that historically the average investor has not fared well investing in the stock market relative to the performance of the market as a whole. The results of the Dalbar Study (DALBAR, INC QAIB 2010) which compares the overall return of US Equity Markets with the actual average return of equity mutual fund investors is quite disturbing. While the US Equity Markets had annualized returns during the 20 year period ending in 2009 of approximately 8.20 percent, the average mutual fund equity investor only realized annualized returns of approximately 3.17 percent.

There were many reasons for the difference, but a big factor was the average equity mutual fund investor’s inclination to enter the stock market during periods of great optimism (the stock market is moving higher), then sell out of the stock market when pessimism prevails (the stock market is moving lower). To say it another way, the average investor has a tendency to buy high and sell low.

Investors need to understand that the largest factor determining their success as an investor during their lifetime is not stock selection, market timing or other gimmicks the financial services industry may put forward, but their behavior. It is imperative that investors make a commitment to being invested in all markets, good and bad, while recognizing markets decline significantly every few years. The key is to not act on fear when the market declines do occur. It is imperative to have faith in the long term prospects for investing that will overcome the fear of the present market environment that will at times be unnerving to say the least.

In summary, to preserve our standard of living through the approximately 30 years of unemployment, we call “retirement,” we should focus more on preserving purchasing power and not just capital preservation.

With the average investor’s less than stellar track record of investing in the stock market, we thought it would be helpful to suggest adoption of 10 resolutions for investors that may help them increase the likelihood of achieving their retirement goals. These resolutions were originally penned by Brad Steiman of Dimensional Fund Advisors.

  • I will not confuse entertainment with advice. I will acknowledge that the financial media is in the entertainment business and their message can compromise my long-term focus and discipline, leading me to make poor investment decisions. If necessary I will turn off CNBC and turn on ESPN.
  • I will stop searching for tomorrow’s star money manager, as there are no gurus. Capitalism will be my guru because with capitalism there is a positive expected return on capital, and it is there for the taking. And for me to succeed, someone else doesn’t have to fail.
  • I will not invest based on a forecast — whether it is mine or anyone else’s. I will recognize that the urge to form an opinion will never go away, but I won’t act on it because no one can repeatedly predict the future. It is, by definition, uncertain.
  • I will keep a long-term perspective and appropriately consider my investment horizon (i.e., how long my portfolio is to be invested) when determining my performance horizon (i.e., the time frame I use to evaluate results).
  • I will stick to my financial plan because it is time in the market — and not timing the market — that matters.
  • I will adhere to my plan and continue to rebalance (i.e., systematically buying more of what hasn’t done well recently and selling some of what has performed well).
  • I will not focus my portfolio in a few securities, or even a few asset classes, as diversification remains the closest thing to a free lunch.
  • I will ensure my portfolio is appropriate for my goals and objectives while only taking risks worth taking.
  • I will manage my emotions by learning about and acknowledging the biases and cognitive errors that influence my behavior.
  • I will keep my cost of investing reasonable.
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