Behavior Gap

There seems to be a considerable amount of concern about a rumor that Democratic Leaders in the U.S. House  are considering confiscating 401(k)s, and IRA. I received an email from a client that was rightfully concerned about what he read in the Carolina Journal Online.

From what I can gather, this all starts from the October 7th Testimony of Teresa Ghilarducci to the Committee on Education and Labor on “The Impact of the Financial Crisis on Workers’ Retirement Security. The full testimony is only 5 pages double spaced, and maybe took 10 minutes to read twice. You can find it here.

A couple of points about the hearing:

• In his opening statement Chairman Miller paints a dire view of the retirement saving landscapes, pledges increased transparency in the 401(k) industry, BUT DOES NOT even come close to suggesting confiscating 401(k) accounts.

• Ghilarducci was one of 5 witnesses that testified before the committee, and as I point out below it does not include any mention of “confiscating” 401(k) accounts.

• Jerry Bramlett, CEO of BenefitStreet a company that  provides 401k plan services was another witness. His testimony does not include any mention of “confiscating” 401(k) plans

In the short term Ghilarducci advocates that congress allow workers to voluntarily exchange their 401(k) for a “Guaranteed Retirement Account composed of Government Bonds (earning 3% adjusted for inflation)”. This must be the source of the rumor.

Whether you agree or not with the suggestion, the point is that a “voluntary exchange” is not even in the same ballpark as “confiscating”!

In the longer term she recommends that the government scale back the tax breaks assocaiated with a 401(k) type plans.

Again this post is not about the merits of her testimony, it is about the contents.

We could argue all day about the merits, but after reading it a few times it would be difficult, and I think irresponsible to suggest that Ghilarducci recommends the forcible confiscation of retirement accounts.

I found a few major talk show hosts (Rush Limbaugh and Sean Hannity) that spun this another way. My only assumption is that they did not take the time to read her testimony.

Other news:

Behavior Gap was included in the “The Carnival of Personal Finance” which is a weekly showcase of the best articles written about personal finance and investing. This week it is hosted here.

“…investors are more unstable than the economy…”

GOOD News: This Volatile October

I have been on a forced media fast for the last week. The non-stop coverage coming from the speculation industry forced me to do it. I turned off the TV, avoided the radio, and stopped reading the news.

It has really become quite silly and totally unhealthy. Investments are LONG-TERM. If you have a financial planner worth anything at all, then your plan includes bear markets.

Why?

Because they happen! Of course the timing of this bear market and the circumstances surrounding it is a total surprise, but the fact that it happened is something that any good planner expected.

That is the point. We can’t know when bear markets are going to happen, but we should plan on them happening. Because we plan on them happening, we should not act surprised when they do.

If we act surprised then we end up doing things like selling our long-term investments along with everyone else glued to CNBC.

Imagine this: for the month of September and the first half of October, $105 billion dollars was pulled out of long-term investments and put, I can only assume, in cash to wait on the sidelines until Jim Cramer declares it safe.

That is $105,000,000,000!

Then, of course, we have these one day 10% moves up. Right after everyone sells…

Like Karen Dolan, Morningstar’s director of fund analysis, has observed:

“Cashing in during a fear-stricken period like the one we’re in now is like watching a bad horror flick where the plot is clear and predictable from the very start. Investors are notoriously bad market timers…we’ve found that investors buy high and sell low to their own disadvantage.”

Like a bad movie…

Remember Long-Term Capital Management?

These were really smart folks.

Being really smart can lead to a high level of confidence in your decisions. Unfortunately history shows that being really smart can also lead to overconfidence.

But it is not just really smart people who have this problem. If you think that we are not all prone to overconfidence try this little experiment: walk into a room of men and ask how many of them consider themselves “better than average drivers.”

This level of overconfidence turns out to be extremely hazardous to your wealth.

The geniuses (I mean that literarily) at Long-Term Capital had estimated their maximum loss on any single day was unlikely to exceed $35 million.

On Friday, August 21, 1998 they lost $553 MILLION.

They were wrong.

Sometimes the most important question we can ask is: What happens if I am wrong?

In some activities, it makes sense to scan the horizon for signals about how we should behave. If you are climbing, it makes sense to carefully watch for signals of a change in the weather that might require you to change your route or descend before you reach the summit to avoid injury or death. If you are a shepherd, it is part of your job to be constantly looking for clues or signs of dangerous predators. For our early ancestors, being on the lookout for signals, interpreting signals, and then taking action was required for survival.

We are hardwired to repeat the cycle of our ancestors:

Look for signals >> Interpret >> Act

When it comes to making smart financial decisions, these genetic wires cause major problems. On an emotional level, we feel that the same rules must apply. We need to be on constant watch for signals that we need to interpret, and then we must act.

But making smart financial decisions does not work that way.

In today’s 24/7 world, we are still looking for signals that will help us survive. Since the loudest signals seem to come from the financial media (the financial entertainment or speculation industry), we start to think that it must matter, that it must be important. So we engage in the same activity: we wake up, fire up CNBC, and watch Cramer. We think that we are just doing what is required for survival, looking for signals. Then, rather than recognize this noise for what it is, we call it NEWS. Then genetics kick in. We try to interpret. Then we act.

Two huge problems:

1. This signal is nothing more than noise! It is entertainment and entertainment and investing DO NOT MIX.
2. In this case our survival actually depends on us doing nothing. Making financial decisions based on NOISE is the worst thing we can do.

Once we have a solid financial plan*, the most important thing we can do is NOTHING. The louder the NOISE, the more important it becomes to ignore it.

At times like these, the only logical conclusion is to go on a MEDIA FAST.

(*Now, if you don’t have a solid financial plan all bets are off.)

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Investor: Someone who makes an investment with the expectation of a long-term increase in value.

Speculator: Someone who buys an asset in hopes of a short term change or fluctuation in price.

Investor: LONG-TERM INCREASE IN VALUE

Speculator: SHORT-TERM CHANGE IN PRICE

One the challenges that we faces as investors (vs. speculators) is that it is rare to hear from other investors.

Most of what we hear is from the speculation industry. Talking about the core principles of investing is boring. Talking about speculation is exciting.

CNBC is exciting. CNBC is entertainment. CNBC is talking about speculation.

The speculation industry (or the financial entertainment industry if you prefer) does not make money based on investment activity. They make money talking about SHORT-TERM CHANGES IN PRICE.

Investors make money based on their investment activities.

Now back to the problem: Investors don’t talk much. What they have to say is generally boring (how many times can you find new ways of saying “buy great things and hold on to them”) and for the most part no one listens to them. But if you look carefully you can find hints of what investors are doing. In a rare exception to this general rule, Warren Buffet wrote an Op-Ed piece in the New York Times this morning. It is worth a read. (Link Here)

Next time you are tempted to act on something you read or heard, ask yourself: “Is this advice from an investor or entertainment from a speculator?”

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One of the reasons we abandon a well-designed investment plan during scary markets is that we believe that if we just get out it will relieve the stress, pain, and anxiety.

• Last week, over $40 billion fled the fear of equities and went to cash, with over $8 billion on Friday alone. That is $8,000,000,000 in one day!
• Some of that represented people who had no plan and most likely have sworn off the stock market forever (or at least until it hits new highs and Jim Crammer starts pounding the table again, “BUY, BUY, BUY”).
• The rest is made up of people that have well-crafted, long-term plans, but have temporally fled to the safety of cash (we call this market timing).
• The market timers felt better over the weekend.
• Monday morning, the relief they felt was replaced by the stress of wondering: “WHEN DO I GET BACK IN?”
• Then to compound that stress, the market had its best day since the Great Depression.

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It has been said that the last four words of any great investor are:

“This time it’s different.”

The argument that this time REALLY is different seems to be louder than any time that I can remember. After all we have never seen a time like this, EVER!

But there is difference between the cause and the outcome.

Yes, the cause of this current scary market is different. One of the things that make scary markets so scary is they all start for different reasons. No bear market is just like another. In light of that, it is a waste of time trying to compare one bear market to another except to recognize that just like the last 20, this bear market will end.

What has never been different is the fact that all scary markets have ended. They have all turned out to be temporary declines in the face of the permanent advance that is part of the core of capitalism.

Assuming that somehow the ENDING of the current scary market is going to be different is simply illogical. It might feel right to sell (see “Manual for Scary Markets“), but it is not logical.

Given the weighty evidence of history, the only logical assumption is that this market will end just like every other scary market in history. And when it does, the only way to participate will be to already be there.

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