A recent survey, reported in Investment News Jan. 9, 2006, conducted by Securities Investor Protection Corp. in Washington concluded that most American investors do not posses the fundamental skills needed to build their savings into retirement nest eggs. When asked a series of questions related to investment knowledge and behavior, only 17 percent demonstrated competence. Let’s not feel badly about this, but instead recognize that we can’t all be experts at everything.
This isn’t to say that most folks weren’t making an effort to understand their investments. Nine out of 10 regularly reviewed their brokerage account and mutual fund statements. Additionally, 74 percent demonstrated that they understood the concept of diversification.
What this study suggests is that reading your statements and understanding diversification just isn’t enough. In fact, this survey suggests many investors fail to consider most of the variables associated with proper investing. It has been my experience that investors forgo consideration of many of the more subtle aspects in favor of simple cookie-cutter solutions and oftentimes simply understanding doesn’t result in action.
I hope that most folks understand that proper diversification is crucial to their overall success. Whether these assets are held within a 401(k), IRA, other qualified plan or your brokerage account, proper diversification is imperative. When implemented, diversification strategies help balance risk and return through a mix of different assets: equities, bonds, cash and alternatives.
Traditionally, one simple concept engrained as “common wisdom” suggests we can assume higher risk earlier in our careers, when we have time on our side, and then transition to lower-risk investments as we approach retirement. This “wisdom” then determines our diversification model. The logic supporting this strategy lies in the fact that as we age we have less time to fix our mistakes and therefore we should assume an increasingly defensive position. Historically, this made sense. However, due to the changes in life expectancy I feel that we can begin to think differently about common-wisdom investment advice which attempts to define our risk tolerance simply based on whether we’re employed or retired.
Why?
The number-one reason is that we’re all living longer. The average life expectancy for a man born in 1941 was just 62 years and for a woman life expectancy was 67 years. This means that for men born in 1941, the average retirement period, assuming a retirement age of 62, was zero. Today, however, a man born in 2000 will live until 74 and a woman will survive until 80, extending the average retirement period for men to 12 years and, for his spouse, 18 years. Let’s not forget that these are just averages. So unlike the retirement of the generation before us, our retirements will be considerably longer and because of good health. Both these variables add additional stress on our nest eggs, requiring investors to consider strategies that will support their longer and more active life spans. (Source: Department of Health and Human Services.)
I think it is important for all of us to understand that proper diversification, including some risk, can help to reduce the biggest risk of all: Outliving our money.
One method to insure we don’t outlive our money is to spend less. Certainly, this should be considered along with the effects of inflation and possibly too conservative an investment strategy which leads to lower returns.
It’s important to understand that even though someone may be retired, he or she often still has a fairly long investment horizon which allows risk in a well-diversified portfolio into the retirement years, a strategy that may have been inappropriate just 20 years ago. Before you move 100 percent of your assets into bonds, cash or fixed investments, speak to a professional. While discussing financial recommendations, take a few minutes to ask about your time horizon and how living longer has been considered in your investment strategy.
Please help me to help you.
Send me your questions, comments and financial fears.
I have begun a collection of real-life stories, antidotes, and misunderstandings of financial issues, which I hope to share here and on KSVY 91.3 Sonoma for the benefit of all readers and listeners.
Your input can be a simple as confessing that you never keep change, i.e. you throw it away, or more complex issues like being very concerned about how others perceive you or your financial actions, or for that matter how you judge others related to their financial habits. I’d like to hear what your little voice is telling you about money and finances, what you hide from your best friends and closest confidants.
I will keep all personal information associated with submittals confidential. I’ll look forward to your input.
Stephen Bossio is the principal of Magnum Financial and the host of Strategies for Creating Wealth live Friday’s from 2-3pm on KSVY Sonoma, 91.3 FM. He welcomes your questions and comments. Stephen can be reached by phone at 707-996-9664 or via email at sbossio@sammonsrep.com. Stephen offers securities through Sammons Securities Company, LLC Member NASD and SIPC. |
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