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8/9/2019 JEW Whitepaper 2010
1/20
BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 1
Introduction
HEN YOU CONSIDER THE CURRENT ECONOMY, THE
last thing you are probably experiencing is irrational
exuberance. Federal Reserve Chairman Alan Greenspan was the
first to use this phrase in the mid-1990s. Only a few years later,
Amazon.com, once merely a retail book
company started in a garage, was trading at
$91 a share with a history of negative
earnings (MarketWatch, 2002). In other
words, people were willing to invest in a
company by purchasing stock that had and
would continue to lose money. If you
contrast this level of performance with that
of the average stock in the S&P 500, you
can see how those Amazon investors were
gambling with their money in response to
irrational exuberance. When Greenspan
coined the phrase, the stock market was
booming, so few people were likely to
heed what we now recognize was a
warning. Shortly after he made the
comment, world markets slumped.
During global economic crises, we read
alarming headlines. Consider the
following:
Recession Starts Taking a Toll:Will it lead to another crash?Worries are building that todays sagging
economy may be on the brink of
collapse.
U.S. News and World ReportThe Death of Equities
7 million stockholders have defected
from the stock market [this decade],
leaving equities more than ever.
Business Week
Running Short of Cash The United States and its allies
scrambled to head off a global financial
disaster. Finance ministers from theUnited States, Britain, France, Japan, and
West Germany met last week near
Frankfurt to find a way to avert a global
economic collapse.
Newsweek
Investor behavior does matter, and it arguably poses thegreatest risk to successful long-term investment experiences.
8/9/2019 JEW Whitepaper 2010
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 1
by James E. Wilson, CFP
These were not pulled from todays headlines. They
come from November 1974, August 1979, and
December 1982 when investors were experiencing great
fear in the midst of bear markets. Fortunately, the
financial world did not come to an end at any point, not
in 1974, 1979, nor 1982. And though national andinternational efforts certainly played a role in the
investors returns, what may have played the most
significant role were individual investors abilities to
make logical decisions in the face of financial fear.
Investor behavior does matter, and it arguably poses the
greatest risk to successful long-term investment
experiences. Furthermore, the outcomes of investor
behavior are even more dangerous to the financial
security of people transitioning into or living in
retirement. This article is the first in a series aboutinvestor behavior and psychology, historical perspectives,
the importance of diversification, and possible solutions
to the challenges investors face.
2
2431 Devine Street
Columbia, SC 29205
888.799.9203
For the complete article series
or for more information about
the wealth management
services offered by J.E. Wilson
Advisors, please visit
www.jewilson.com.
Copyright 2010
All rights reserved.
Please feel free to pass on this
article for personal use.
However, no part of this
publication may be reproduced
or retransmitted for commercial
use in any form or by any means,
including, but not limited to,
electronic, mechanical,
photocopying, recording or any
information storage retrieval
system, without the prior written
permission of the authors.
Unauthorized copying may
subject violators to criminal
penalties as well as liabilities for
substantial monetary damages up
to $100,000 per infringement
including costs and attorneys
fees.
8/9/2019 JEW Whitepaper 2010
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 2
Source: Qualitative Analysis of Investor Behavior, DALBAR, Inc, 2008
Why is Investor Behavior So Important?
ERHAPS THE MOST IMPORTANT INGREDIENTS TO long-
term financial security are the decision-making abilities and
behavior of the investor. DALBAR, Inc., a company that provides
standards, research, and ratings for those in the financial
industries, published a report in 2008
that shows the effect of investor behavior
on financial investments. According to
that study, the S&P 500 earned anannualized return of 11.81% during the
20 years ending in December 2007,
which was a period of strong bullish
markets, while the average equity
investor only earned 4.48%. Despite the
opportunities, in other words, the average
investor earned only 38% of the available
return as a result of making poor
decisions throughout the twenty year
period. To better understand thepractical implications of these numbers,
consider the following: assume an
investor had put $100,000 into an S&P
500 mutual fund in 1988 and earned its
average return of 11% between then and2007. Even after the bursting of the
2000 - 2002 Tech Bubble, the value ofthat investment would have grown to
$806,231. Hampered by flawed decision-
making abilities, however, the average
investor actually achieved a 4.48% return
during the same period. That hypothetical
investment of $100,000 would only have
grown to $240,249. The behavior of our
hypothetical average investor ended upcosting him a difference of over
$560,000.
P
8/9/2019 JEW Whitepaper 2010
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 2
by James E. Wilson, CFP
This is a loss of 69% of the available return of $806,231.
Unfortunately, most investors fall prey to a thought
process that prevents them from always making logical
decisions instead of decisions based more on emotionalresponses. The consequences may mean the difference
between retiring with financial security, peace, and
confidence and the alternative of retiring in what would
feel like relative poverty.
This article is the second in a series of lessons about the
barriers investors face as they work to achieve financial
security. The first article introduced the series, and the
next article will outline how investors are often their own
worst enemies.
2
Next Issue: Your Portfolios Worst Enemy
2431 Devine Street
Columbia, SC 29205
888.799.9203
For the complete article series
or for more information about
the wealth management
services offered by J.E. Wilson
Advisors, please visit
www.jewilson.com .
Copyright 2010
All rights reserved.
Please feel free to pass on this
article for personal use.
However, no part of this
publication may be reproduced
or retransmitted for commercial
use in any form or by any means,
including, but not limited to,
electronic, mechanical,
photocopying, recording or any
information storage retrievalsystem, without the prior written
permission of the authors.
Unauthorized copying may
subject violators to criminal
penalties as well as liabilities for
substantial monetary damages up
to $100,000 per infringement
including costs and attorneys
fees.
8/9/2019 JEW Whitepaper 2010
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 3
Your Portfolios Worst Enemy
HIS YOUNG CENTURY HAS ALREADY FELT THE POPS and
drops of two investment bubbles one in 2002 and the
other in late 2008 and early 2009. Some investors may have
mostly escaped the impact of one, or perhaps both of them, but
behavioral finance, a relatively new
academic field, teaches us that investors
can still be vulnerable to the momentum
created by fear and greed, even if they arenot hit by each downturn in the market.
In order for investors to continue to be
safe from this momentum, they have to
understand how their behavior impacts
portfolio performance. In their efforts to
achieve long-term security, they may find
it helpful to recognize that during the
extraordinary expansion of the housing
bubble and the most recent sell-off in thestock market, many responded
emotionally and with at least some
disconnect in logical reasoning. At an
extreme level, this disconnect can lead to
a suspension of the traditional benefits of
business acumen and fundamental and
technical analysis. To help investors bring
the challenge of
Emotionally driven behavior into
perspective, future articles will attempt to
explain some of the challenges presented
by psychological forces that impede ourfinancial success, and they will cover the
following aspects of investing:
A historical journey to betterunderstand economic cycles;
Psychological tendencies and thechallenge of overcoming these
tendencies to become good
investors;
How our financial survival dependson our ability to identify these
challenges;
Hard and fast solutions.
Investors should understand how their own behaviorimpacts portfolio performance.
T
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 3
by James E. Wilson, CFP
This article is the third in a series about the barriers
investors face as they work to achieve financial
security. Previous articles introduced the series and
the importance of investor behavior. The next article,
included with this one, will provide a historicalperspective for investors.
Next Issue: A Historical Perspective
2431 Devine Street
Columbia, SC 29205
888.799.9203
For the complete article series
or for more information about
the wealth management
services offered by J.E. Wilson
Advisors, please visit
www.jewilson.com.
Copyright 2010
All rights reserved.
Please feel free to pass on this
article for personal use.
However, no part of this
publication may be reproduced
or retransmitted for commercial
use in any form or by any means,
including, but not limited to,
electronic, mechanical,
photocopying, recording or any
information storage retrievalsystem, without the prior written
permission of the authors.
Unauthorized copying may
subject violators to criminal
penalties as well as liabilities for
substantial monetary damages up
to $100,000 per infringement
including costs and attorneys
fees.
8/9/2019 JEW Whitepaper 2010
7/20
BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 4
Historical Perspective
VEN THOUGH EACH BEAR MARKET SEEMS UNIQUE,investors can gain some perspective if they review the
similarities of bear markets over the last fifty years a period
during which we have faced ten particularly challenging intervals
in market conditions, including the one
we are now experiencing. Approximately
every five years, the market enters a
period of correction that is a naturalprocess of the risks and rewards of
capitalism, and each time, we have
recovered from the slump in the cycle.
To better understand these patterns from
a historical perspective, consider three of
the most recent bear markets:
January 11, 1973 to October 3, 1974
The causes of the economic fright
experienced by Americans in the 1970s
include the Vietnam War, Watergate, an
oil embargo, a double digit
unemployment rate, and a 16.8%
increase in the cost of living. Over the
course of 23 months, the market lost
45% of its value, and many investors
eventually turned to the safety of CDs
and bonds. Such extreme conditions hadnot been experienced in the United
States since the Great Depression.
A 1974 Time magazine cover stating
Recessions Greetings reflected the fear
of the nation, and the cover storys title
prophesied Gloomy Holidays and
Worse Ahead.
The article begins, Not for many years
has a Christmas season begun with somany tidings of spreading discomfort and
lack of joy about the U.S. economy.
Already wracked by a devastating double-
digit inflation, the nation is now also
plunging deeper into a recession that
seems sure to be the longest and could
be the most severe since World War II.
Despite Times grim predictions,
economists now agree that December1974 actually marked a turning point in
the U.S. market: the S&P 500 soared
37.2% and 23.9% in 1975 and 1976
respectively.
August 26, 1987 to December 4, 1987
This bear market was as extreme as it
was short. On a day known as Black
E
8/9/2019 JEW Whitepaper 2010
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 4Monday, the crash of markets around the
world on October 19, 1987 also sent the
Dow Jones Industrial Average
plummeting 22.61%, which is still the
largest one-day percentage decline in
history. (In contrast, the stock market
crash of 1929 included only a 12.82%
decline on its Black Monday.) As in 1974,
the plummet of the Dow panicked many
investors who desperately looked for
financial safety elsewhere.
Again, Time magazine provided another
cover story depicting Americans dismay.
One story presented an hour-by-hour
account of events, and another argued
that the U.S. . . . could not go on forever
spending more than it would tax itself to
pay for, buying more overseas than it
could earn from foreign sales, and
borrowing more abroad than it could
easily repay. There had to be a day of
reckoning, and it could unhinge the
whole world economy. The disapprovaland pessimism of this seemingly
timeless statement gave investors little
hope for the immediate future. However,
almost half of the Black Monday losses
were recovered in the days following the
sell-off, and less than 3 months later, the
S&P 500 finished the year up 2.3%.
Overall, the 1980s ended with a
compound return of the S&P 500 of
17.6%.
March 24, 2000 to October 19, 2002
While many people remember the crash
of the stock market following the
September 11 terrorist attacks, this multi-
event decline actually began with the
earlier bursting of the technology bubble
in 2000. By October 2002, at the end of
an exhausting 28 month period, the S&P
500 had lost 49.2%, and a young
generation that had previously feltindestructible suddenly felt very
vulnerable. The September 14, 2001
Time magazine cover depicts the World
Trade Centers Twin Towers in the final
moments before their collapse.
One of the many signs that our country
had come to a complete halt was the
closure of the New York Stock Exchange
for 4 days after the attacks. Once the
markets reopened, the Dow JonesIndustrial fell more than 17% over the
course of a week.
In 2001, the United States and its
economy was vulnerable to outside
forces and to the loss of its strong
technology sector because of the
8/9/2019 JEW Whitepaper 2010
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 4
exposure of hidden greed in corporate America. 2002
was defined as the year corporate titans WorldCom and
Enron collapsed and the year that $2 million birthday
parties funded by the corporate dollars of Tyco ended.
As dark as the outlook was following the collapse of thetechnology bubble and the devastation of September 11,
the markets eventually recovered: the S&P 500
appreciated 14.3% in value between early 2003 and late
2007.
Despite oil embargos, double-digit inflation, the burst of
the 1990s technology bubble, and September 11, the
past 35 years have produced a whopping appreciation of
3,725% in the S&P 500. Investors cannot invest directly
in the S&P 500, but if they could have invested $100,000
in the early 1970s, their investments would potentially
have appreciated to over $3.7 million during those 35
years, assuming that our hypothetical investor had not
fallen victim to the greed and emotionally-driven
behavior that plagues the average investor. Though a
natural response is to panic when facing a challenging
bear market, we are less likely to make faulty decisions if
we can keep such market fluctuations in perspective.
This article is the fourth in a series of lessons about the
barriers investors face as they work to achieve financial
security. Previous articles introduced the series and
outlined the ways investors behavior impacts their
decisions. The next article will explore the psychological
tendencies of investors and the challenge of overcoming
such tendencies as we explore the emotional and
intellectual responses a number of investors experience
as part of the investment process.
Next Issue: Our Money and Our Brains
2431 Devine Street
Columbia, SC 29205
888.799.9203
For the complete article series
or for more information about
the wealth management
services offered by J.E. Wilson
Advisors, please visit
www.jewilson.com .
Copyright 2010
All rights reserved.
Please feel free to pass on this
article for personal use.
However, no part of this
publication may be reproduced
or retransmitted for commercial
use in any form or by any means,
including, but not limited to,
electronic, mechanical,
photocopying, recording or any
information storage retrievalsystem, without the prior written
permission of the authors.
Unauthorized copying may
subject violators to criminal
penalties as well as liabilities for
substantial monetary damages up
to $100,000 per infringement
including costs and attorneys
fees.
8/9/2019 JEW Whitepaper 2010
10/20
BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 5
Our Money and Our Brains
O FEEL EXCITED WHEN OUR PORTFOLIOS INCREASE in
value and to experience fear when they decrease in value is
perfectly normal and acceptable. However, these emotions
become problematic once we start making decisions based on
emotional entanglements that limit our
ability to reason. To prevent ourselvesfrom making such decisions, we first have
to recognize our capacity to make poor
financial decisions based on emotions in
order to then recognize the emotions that
drive them. In response, we can then
take a more defensive stance that could
potentially limit the risk of damaging our
long-term financial security.
First, identify the enemy. We are our own worst enemies when it comes to
managing our finances. When we
understand how we tend to respond in
certain circumstances, we can develop a
plan to defend our finances from our
emotional responses the next time we
have similar experiences.
Second, recognize the challenges. You
are likely very familiar with the excitementof financial gain and the fear of financial
loss; however, you probably are not
aware of how your brains wiring
influences those responses. Investing
affects us not only emotionally and
psychologically but physiologically as well.
Neuroeconomics, the study of
neuroscience, economics, and
psychology, shows that any thoughts or
decisions about financial profit use thesame part of our brains that is hardwired
to pursue pleasure. In contrast, the
experience of financial loss is processed
by the part of our brain that triggers a full
reaction to pain or danger and causes
fight or flight. Your brain is so sensitive in
such situations that it even responds
differently if you are planning for short-
term monetary rewards than if you are
planning for long-term ones (Technology
Review, May 2005, Huang). In other
words, your responses to investment
plans and outcomes are very complex.
Once you recognize these responses in
your own behavior patterns, you will have
a better chance of achieving financial
security. Recognizing them will also help
you keep your emotions in check the nexttime we face a bear market, which is a
part of every five year cycle. Jason Zweig,
a columnist for the Wall Street Journal
and editor of the revised edition of
Benjamin Grahams The Intelligent
Investor (2003), expands on this mental
response with an analogy: There is not
much difference in the brain between
T
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 5
having a rattlesnake slither across your
living room carpet and having some stock
you own go down by 40% or 50%.
Recognizing that you may not have much
of a chance battling a rattlesnakebarehanded, you might resort to a flight
response because you merely hope to get
out alive. Not surprisingly, you may feel
similarly in response to a disastrous drop
in the value of your investments.
Additional psychological forces include
personal biases, emotions, and past
experiences, all of which can influence
even experienced investors. Somepsychological forces are quite obvious
while others are very subtle.
Nevertheless, there are psychological
pitfalls you can be aware of and
straightforward advice you can use to
help mitigate their impact. A few of these
include a fear of regret, myopic risk
aversion, overconfidence, and the herd
mentality.
Fear of RegretInvestors who are affected by fears of
regret put off financial decisions because
they hope to get even more information
and feel even more confident before
having to make decisions. Consequently,
these investors sometimes hold on to
losing stocks for too long or sell winning
stocks too quickly. They hold on to losingstocks rather than accept a loss for two
reasons: they hope the investments will
eventually make gains, and they feel as
though selling them confirms that they
had made a mistake by buying them in
the first place. Those with winning stocks
sell too quickly because they want to do
so before the stocks start to lose value
they hope to quit while they are ahead.
If you tend to worry that you will regret
similar investment decisions, listen toDeena Katz, a chairman for Evensky and
Katz Wealth Management: My mom
always said, if youre going to do it, dont
worry; if youre going to worry, dont do
it. Youve already made the commitment
to be where you are invested . . . Youre
there. And unless you need to get out,
youre committed (Money, May 2008).
Myopic Risk AversionMyopic risk aversion certainly sounds like
something you would hear in an eye
doctors office, and it actually does relate
to a type of vision. People exhibiting
myopic risk aversion cannot focus on
long-term gains because they are too
fixated on short-term losses. Such a
focus makes sense psychologically, but it
could be an exceptionally dangerouspitfall for investors right now. Even those
who are usually confident about their
long-term investment goals may become
anxious about recent fluctuations in the
market and might end up losing money
unnecessarily because they can only
focus nearsightedly on the immediate
future. To avoid this pitfall Robert Arnott,
the founder and chairman of ResearchAffiliates (a developer of investment
products) suggests that rather than ask
yourself what you can do to make money
in the next three months you should ask
yourself, What would I want my portfolio
to look like over the next 30 years?
(Money, May 2008).
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 5
OverconfidenceOverconfidence is somewhat the
opposite of myopic risk aversion. Recent
research indicates that many investors,
especially men, overestimate their own
abilities as well as the accuracy of the
information they gather prior to making
financial decisions. As a result,
overconfident investors tend to overtrade,
which usually leads to lower returns. An
article in the February 2007 issue of Inc.
explains that overconfidence is one of
the worst failings an investor can have.
Despite the temptation to guess thefuture or try to control what will happen
(both of which are forms of
overconfidence), investors have to admit
that neither is possible to do, no matter
how confident they may feel in their
abilities.
Herd MentalityAs Niccolo Machiavelli explained,
[People] nearly always follow the tracks
made by others. Such behavior causes
us to go along with the collective wisdom
and tastes of the larger masses in a
variety of situations. Clothing fashions,
community circles, automobile selection,
and even investing habits reflect that
humans are social creatures who are very
likely to follow the herd. When it
comes to investing, social environmentsand the media heavily influence people
into jumping blindly on the investment
bandwagon without employing sound
reasoning and research. Therefore,
unfortunately, investors will unwittingly
follow the herd even if the herds
direction is to the detriment of the
investors personal and financial goals
and even if doing so goes against their
individual reasoning abilities. The Madoff
Scandal illustrates this tendency perfectly.
Many people, who had long beensuccessful investors, forgot about the
importance of research, prudence, and
diversification in large part because they
followed peers who were investing with
Bernard Madoff. Recognizing the role
societal influences played, David Zarolli
reported in a December 2008 story for
NPRs All Things Considered that it
was prestigious to invest with him. In
fact, people even joined his country clubin Florida merely to meet him and get a
personal invitation to invest with him. In
addition to a prestige factor, behavioral
finance experts explore other key reasons
we are willing to follow the herd. The
Market Analysis, Research, and Education
group, a unit of Fidelity Managements
research company, explains that an
investor may follow the herd because he
or she feels an intuitive sense of
conformity, whereby aligning oneself with
the consensus of a large group going in
the same direction is more comfortable
than making an alternative, less-popular
choice. If we follow the direction of a
larger group of investors, we can act
based on the assumption that many
others must have access to superior
knowledge. And how could so manyothers be wrong? Conversely, we tend to
believe that the groups that we are part
of are naturally more likely to be right.
(Otherwise, we would not experience the
sense of affinity that defines those groups
to begin with.)
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 5
Including the original Ponzi Scheme,
there are quite a few historical examples
when a number of individuals have fallen
prey to the herd mentality. One, Tulip
Mania, caused wealthy Dutch investors tospend obscene amounts of money on
tulip bulbs or on shares of bulbs. Some
even went so far as to trade houses so
they could invest in one or two tulip
bulbs! Such examples are evidence of
the irrational behavior humans are
capable of exhibiting, and we seem to be
especially vulnerable when we are
following others.
An investment trend in the late 1990s
also demonstrates a similar but
complicated example of herd mentality.
During the emergence of the New
Economy, Warren Buffet was ridiculed
for his arcane investment theory because
others believed that the New Economy
marked a period when globalization and
the acceleration of developments in
information technology began to changeeconomic trends. The mainstream media
extolled the possibilities offered by this
New Economy. As early as June 27,
1994, John Huey of Fortunewrote, The
advent of the new economy is
unequivocably [sic] good news for the
U.S., which holds a wide lead over the
rest of the world in developing, applying
and now exporting
technology.
Whenreferring to the New Economy, a
September 27, 1999 Time magazine
article titled Get Rich.com asked, If
you're an entrepreneur, why waste your
time in the old world, worrying about
manufacturing things and dealing with
unions and OSHA inspections, when you
can put your company online in three
months? If only people had listened
more to Warren Buffet and less to the
medias promotion of the New Economy.
One way to better appreciate the
investment trend in the late 1990s is to
study the relationship between net sales
of equity mutual funds. During the first
quarter of 2000, as seen at Point 1 in the
graph on the next page, the stock market
was coming off of five straight years of
double digit gains, and many of those
gains were led by technology stocks.
Between 1995 and 1999, the S&P 500advanced 251% while the tech-heavy
Nasdaq advanced 457%. In January
2000, at the peak of this multi-year rally,
a record number of media headlines
alluded to a bull market. Then, as it
turned out, the first quarter of 2000
ended up being the peak of the market:
over the next three years, the Nasdaq
plummeted 67%, which meant
devastating losses for those investors who
had concentrated heavily on technology
stocks. Those who had followed the herd
and entered the market during the later
stretches of the metaphorical stampede
likely suffered the greatest losses because
they had joined the herd at the riskiest
time.
Joining the herd as it ventures into newterritory and takes new risks can be just
as costly as joining it too late because
those who follow the herd to supposed
safety allow themselves to be led out of
the stock market at the wrong times, too.
In the final quarter of 2002, for example,
after nearly three consecutive calendar
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 5
years of downturns in the stock market,
the number of headlines that suggested
the possibility of a continuing bear market
rose significantly. In response, investors
became increasingly fearful and anxiousbefore finally reaching the point of
capitulation. Between June and October
2002 (Point 2), the S&P 500 declined
16% and the Nasdaq declined 18% in
just five months. Investors pulled a
monthly average of 13 billion out of
equity mutual funds compared to the
average monthly inflow of 19 billion that
had continued during the previous five
months.
As the graph below shows, people were
buying when it would have been a better
time to sell (Points 1 and 3) and were
selling when it would have been better to
buy (Point 2). It is worth noting that
some investors did act individually and
may not have focused only on long-term
investments. Regardless, both types of
investors lost money because of poor
decisions and bad timing.
Just as these investors retreated from
equities during the second half of 2002,
many also shifted their money into
money market funds because of their
relative safety. In November 2002, a
record of 136 billion in net sales flowed
into these money market funds
suggesting that many investors were
turning away from stocks near the bottomof a three-year bear market. In fact, by
the end of 2002, the level of ownership
in money market funds reached an all-
time high of nearly 35% of all
outstanding United States mutual fund
assets. At roughly the same time, the S&P
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 5
500 began a sharp comeback: it rose 29% in 2003,
which helped jumpstart a five-year bull market rally. For
those who had recently decided to follow the herd by
concentrating their portfolios into cash-like investments,
the move may have been very costly.
If you have ever been misguided because you followed
the herd, do not be too hard on yourself. Stephen
Greenspan, the author of the book Annals of Gullibility,
accounted in a recent Wall Street Journal article how
even he, someone knowledgeable about what can
happen as a result of trust and/or ignorance, lost some
of the savings he had accumulated from his book sales
to Bernard Madoff. Greenspan explains in the article
how some risks are more hidden and, thus, trickier torecognize than others (2009). Investors of all
experience levels need to always be cognizant of the
aspects of investing that influence their financial
decisions.
This article is the fifth in a series of lessons about the
barriers investors face as they work to achieve financial
security. Previous articles introduced the series, explored
the importance of investor behavior in financial planning
and provided an overview of the significant fluctuationsin the market over the last 35 years. The next article will
reinforce the importance and value of diversification.
by James E. Wilson, CFP
Next Issue: Diversification
2431 Devine Street
Columbia, SC 29205
888.799.9203
For the complete article series
or for more information about
the wealth management
services offered by J.E. Wilson
Advisors, please visit
www.jewilson.com.
Copyright 2010
All rights reserved.
Please feel free to pass on this
article for personal use.
However, no part of this
publication may be reproduced
or retransmitted for commercial
use in any form or by any means,
including, but not limited to,
electronic, mechanical,
photocopying, recording or any
information storage retrievalsystem, without the prior written
permission of the authors.
Unauthorized copying may
subject violators to criminal
penalties as well as liabilities for
substantial monetary damages up
to $100,000 per infringement
including costs and attorneys
fees.
8/9/2019 JEW Whitepaper 2010
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 6
Diversification
OST PEOPLE UNDERSTAND THE BASIC CONCEPT
behind diversification: do not put all of your eggs into
one basket. However, even people who are
sophisticated investors can fall into investment traps. For
example, many people have suffered
losses because they placed a large
percentage of their investment capital in
their employers
stock only to lose muchof it during the recent downturn. Even
though the employees may have
understood that they were taking too
much of a risk in doing so, they did not
do anything to change their situations.
Instead, they justified holding the position
they had established because of the large
capital gains tax they would have to pay
upon selling the stock, or they imagined
that the stock was just on the verge oftaking off. In such instances, investors are
too close to a particular stock, and they
develop a false sense of comfort and
overconfidence. They may rationalize that
everyone with whom they work has
invested in the company, and how could
so many people be wrong? Similarly,
they rationalize the importance of their
investment in the company
s stockbecause they are professionally invested
in the company and feel a certain sense
of loyalty. Over the past year alone, many
of these investors have felt the pain of
such imprudent investment practices.
In much the same way, other investors
believe they have diversified their
portfolios effectively because they own a
number of different stocks. What they
may not realize, however, is that they are
in for an emotional rollercoaster ride if
these investments all belong to the same
industry group or asset class and
therefore share similar risk factors. For
instance, investors in the late 1990s and
early years of this decade learned thatdiversification among a variety of high
tech stock companies was really not
diversification at all. When a number of
prominent technology stocks, including
Cisco, Dell, and IBM, experienced billion
dollar sell-offs between Friday, March 10
and Monday, March 13, 2000, the
resulting chain reaction hit the entire tech
industry.
Included with this article are charts that
will help investors understand how
diversification dramatically impacts a
M
8/9/2019 JEW Whitepaper 2010
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 6
by James E. Wilson, CFP
portfolio. (It is important to remember, however, that
one cannot directly invest in the S&P 500. This chart
uses it as an index for illustration purposes only). So,
imagine someone whose hypothetical portfolio consisted
of a 100% investment in the S&P 500 (Portfolio 1).Between 1998 and 2007, he would have achieved a
4.38% annualized compound return and for every $1.00
invested, he would have ended up with $1.47. However,
if he had merely invested 40% in a 2-Year Global Fixed
Income Fund with the remaining 60% still in the S&P
500 (Portfolio 2), his annualized compound return
increases to 4.72% and each dollar is now worth $1.51.
Portfolio 5 shows additional diversification including
investments in U.S. small and large value companies as
well as in real estate. The annualized compound returnof Portfolio 5 jumps to 8.9% while the growth of $1
reaches $2.15. Adding international stocks to Portfolio
10 even better demonstrates the potential of
diversification because it achieves more than double the
annualized compound return of Portfolio 1 (10.08%),
and our investors $1 has now reached a value of $2.37.
Explained this way, the benefits of diversifying are
obvious; however, many people fail to take advantage of
the potential of diversification.
Next Issue: Hard and Fast Solutions
2431 Devine Street
Columbia, SC 29205
888.799.9203
For the complete article series
or for more information about
the wealth management
services offered by J.E. Wilson
Advisors, please visit
www.jewilson.com .
Copyright 2010
All rights reserved.
Please feel free to pass on this
article for personal use.
However, no part of this
publication may be reproduced
or retransmitted for commercial
use in any form or by any means,
including, but not limited to,
electronic, mechanical,
photocopying, recording or any
information storage retrievalsystem, without the prior written
permission of the authors.
Unauthorized copying may
subject violators to criminal
penalties as well as liabilities for
substantial monetary damages up
to $100,000 per infringement
including costs and attorneys
fees.
8/9/2019 JEW Whitepaper 2010
18/20
BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 6
8/9/2019 JEW Whitepaper 2010
19/20
BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 7
Hard and Fast Solutions
E WILL DISCUSS SOLUTIONS MORE EXTENSIVELY in afuture volume of articles, but they are worth
summarizing here as well.
Investor Behavior & the Buy-Sell Cycle:Investors frequently engage in a buy-sell
cycle that can be destructive to their
portfolios as long as they are not aware of
their behavior or able to modify it. Quite
simply, this cycle begins with thepurchase of stock that an investor
believes will be particularly lucrative.
Greed kicks in and all is well until the
stock begins to lose value. As soon as
this happens, the investor experiences
fear, regret, and, eventually, panic if the
stocks value continues to decline. The
investor sells the stock just before new
information comes out that will send its value soaring. Recognizing and
understanding this potential behavior will
help investors avoid it.
Cash Flow Models: As investors assesswhere they are financially and where they
would like to be, they will find cash flow
models to be incredibly helpful tools.
Whether trying to focus on the immediate
future or trying to plan for retirement,
investors who utilize cash flow models
can avoid making rash, costly mistakes.
An informed investment advisor, and
even online tools, can help you developan accurate cash flow model.
Managing Investment Costs: A valuedadvisor can manage clients investments
objectively and can assist clients in
making research-based decisions, which
is important since investors can only
control those factors of which they are
aware. Similarly, such an advisor can also
help clients limit the cost of investing,which in turn increases the amount of the
investment return that clients keep in
their pockets.
Managing Risk and Reducing Volatility:Investors will manage risk and reduce
volatility more effectively if they have an
efficiently designed portfolio. For every
level of risk, the portfolio should take into
account the optimal combination of
investments that will give the highest rate
of return.
To do so, investors can utilize a variety of
resources to stay informed and may also
benefit from working with a valued
advisor.
W
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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vo l. 1, Issue 7
Conclusion: Now that you have some historical context,consider where we are today. During the first quarter of
2009, investors moved 285 billion in new net capital into
money market funds and withdrew a net 31 billion out
of equity funds. Do these changes suggest herdbehavior? Perhaps. However, what long-term investors
need to recognize is that if they radically alter their well-
diversified portfolios, they also need to be prepared to
assume a higher tolerance for risk. For example,
investors who may have significantly lightened their
exposure to risk by selling stocks in late 2008 and early
2009 might not have moved back into the market to
participate in the 38% rally that took place between mid-
March and mid-June of 2009. (On March 9, the S&P 500
was at 676.53, and by June 8 it was up to 939.14.) Though it begins to sound like a broken record,
maintaining a diversified portfolio with exposure to
multiple asset classes throughout a variety of market
cycles really is the strategy that has provided investors
with the least volatility in their returns. And these returns
also end up being the most consistent with investors
expectations.Investors face a number of challenges if they plan to
have successful investment experiences over the years.Of primary concern are the psychological impediments
that make it difficult for us to make good decisions
consistently. Investors also face the certainty of market
volatility, as evidenced by historical trends. Therefore,
they should utilize the resources necessary to manage
investment costs and to process current academic
research on corporate stock pricing, portfolio
construction and management.
Additionally, take the time to remember the impact your
emotions can have on your decision-making abilities
when you are making financial decisions. Consider
carefully not only the decisions you are facing, but also
why you are contemplating them in the first place. Just
being aware of the emotional complexities of making
financial decisions will help you achieve financial
security.
2431 Devine Street
Columbia, SC 29205
888.799.9203
For the complete article series
or for more information about
the wealth management
services offered by J.E. WilsonAdvisors, please visit
www.jewilson.com.
Copyright 2010
All rights reserved.
Please feel free to pass on this
article for personal use.
However, no part of this
publication may be reproduced
or retransmitted for commercial
use in any form or by any means,
including, but not limited to,
electronic, mechanical,
photocopying, recording or any
information storage retrievalsystem, without the prior written
permission of the authors.
Unauthorized copying may
subject violators to criminal
penalties as well as liabilities for
substantial monetary damages up
to $100,000 per infringement
including costs and attorneys
fees.