The Real Reasons Why You Buy

(from Carl Richard's New York Times' Bucks blog, 4/16/2012 - click here for the original post. Carl is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.) His new book The Behavior Gap is on shelves now.

Before we buy something we tell ourselves stories.

We are particularly fond of the story that goes like this: We have researched all the options, and the decision we have made represents that best one we could make given the facts. Just the cold, hard facts.

Of course, that story isn’t really true.

And we make up other stories as well, many of which have absolutely nothing to do with the actual facts. We create these stories to help ourselves feel good about a decision we have already made.

For instance, many times we actually reverse the process. We decide what we want, often for emotional reasons, and then we go looking for evidence to support the decision. As we are gather the evidence, we carefully omit anything that doesn’t fit into the story we’re writing.

This is so easy to do you could say that it’s natural to us. We don’t really have the time to consider every single option. If you did, you would never get past your closet in the morning. So we take shortcuts. We decide what we want and then gather a few facts to prove to ourselves, our spouse and our family or friends that we did the right thing.

When it comes to spending money, one of the stories we like to tell ourselves is that we aren’t just spending. This item is actually an investment. It’s an investment in ourselves and our quality of life, or an investment that will actually save us money over the long run.

So we run the numbers, or more likely we read about someone who ran the numbers. Then if the narrative matches, we use that as evidence that we’re doing the right thing.

It seems easy. A simple case of addition or subtraction.

Things get complicated pretty quickly, however, when we start using the argument of saving money as a Trojan horse to hide the real reasons we’re doing something. Let’s take the case of whether to buy a hybrid or electric car.

If you decided that you want a hybrid, it’s pretty easy to find evidence to support that decision, but be careful if you’re telling yourself that it will save you money.

Except for two hybrids, the Prius and Lincoln MKZ, and the diesel-powered Volkswagen Jetta TDI, the added cost of the fuel-efficient technologies is so high that it would take the average driver many years — in some cases more than a decade — to save money over comparable new models with conventional internal-combustion engines … Gas would have to approach $8 a gallon before many of the cars could be expected to pay off in the six years an average person owns a car.

To be clear, there are plenty of legitimate reasons to buy a more fuel-efficient car. Unfortunately for the buyers relying on the numbers argument, one of them isn’t saving money in the short term unless you buy specific models.

So why do we hide behind saving money?

It’s easy to point to the price of gas. It’s harder to explain why the environment benefits from one more person driving an electric car. And it’s harder still to explain why driving a hybrid just makes you feel good.

And few people want to admit to adult peer pressure. How could you live with the story that you actually bought that Prius because you wanted a cool spot to put your Apple sticker?

Obviously cars aren’t the only thing we try to make the saving-money logic stick to. How about the recent argument at Slate that you should run out and “buy, buy, buy” a house if you are currently renting? This is a classic case of using tons of “evidence” to tell a nice little story while ignoring the data that might not fit nicely in the narrative.

Based on the facts presented in this particular story, it looks like it might actually be cheaper to buy than rent, but it states that any consideration of where prices might be headed is “irrelevant.” It’s just one more example of how far we can go in our storytelling exercises.

And it’s not that simple, as you’ve probably guessed. What if prices fall 10 percent and you have to relocate for another job? What if you know you’re moving in three years and prices stay the same?

You may be very hard pressed to break even after you consider the costs associated with buying and selling the house (e.g., real estate commissions, closing costs, moving costs and taxes). With a little honesty, there goes that nice, clean “time to buy” story.

While cars and houses might require the most complex stories, we often tell ourselves little ones about things like vacation “deals,” using a rewards credit card and buying in bulk. Often they get brushed with the halo of saving money. In each instance, saving money may be one of the reasons you’re doing something, but you can rarely say that it’s the only reason.

And that’s the point.

We tell ourselves stories about why we’re buying something, and saving money is a good story.

But I think one of the best conversations you can have with yourself, your spouse or your family is about the real reasons behind why you spend money. Be honest, even if it means having to admit that you’re buying something only because you simply want it. Blurring our reasons for our decisions around spending money is a slippery slope that can lead to a lot of financial headaches.

A Plan for 2012 That You'll Actually Follow

(from Carl Richard's New York Times' Bucks blog, 12/26/2011 - click here for the original post. Carl is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)  His new book The Behavior Gap, will be out in January.

For 2012, I have a challenge for you: make financial decisions on purpose. Too much of what we do is based on habits and assumptions instead of a thoughtful plan. During the next year, see what happens when you do these three things:

1) Define your current reality. I used to think this was the easy part. Turns out I was wrong. Most people don’t know where they actually stand financially.

After the last few years, it’s tough to face the reality of our situations. Even if you have a sense that things have gone well for you financially, building a personal balance sheet doesn’t rank very high on the fun meter, but it has to be done. It makes it hard to reach any goal if you have no idea where you are starting from.

2) Set some goals. This step hangs people up because often we have no idea what we will be doing in five days, let alone five years. Still, it’s really hard to get somewhere if you don’t know where you’re going.

Let go of the need for precision. These are guesses, so make the best guess you can and move on. How important is paying for college for your child or children (or grandchildren)? Define it a bit. How much will it cost, what can you save, when will it happen?

Be honest. Be realistic. Of course part of this process will involve making some assumption about rates of return you will earn. Be conservative and focus instead on having realistic goals and saving more. If you can’t save more, maybe spend some time trying to earn a bit on the side.

3) Commit to course corrections. Plan on them, in fact. Break down what you have to do into quarterly action steps, and then revisit the plan every three months.

If you are off course, make changes while you’re only a little bit off. If you leave Los Angeles on a flight to New York City and you’re a half inch off course, it’s much easier to adjust when you are over Nevada than it will be a few miles outside of Miami.

Planning for a better financial future is an continuing process, not a single event. It is also short-term boring but long-term exciting.

In 2012, commit to doing small, simple things consistently and over time. It will be the opposite of what we’ll hear in the news every day about making enormous changes, so part of the challenge will be to ignore the constant call for rash actions and sweeping reform.

Let’s make 2012 about subtle, small actions so we can make progress towards our goals over a long period of time.

The Struggle to Define What We Truly Need

(from Carl Richard's New York Times' Bucks blog, 10/17/2011 - click here for the original post. Carl is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)

There seems to be a constant battle between what we have, what we need and what we think we want.
About a year after my wife and I had our first child, we moved into a neighborhood with homes built decades earlier. Each had two or three bedrooms. We soon noticed that when people had a third or fourth child they moved from the neighborhood in search of more space. One day I mentioned this to my next-door neighbor, who was 70 at the time, and he expressed surprise.

He and his wife had raised their five kids in one of the smallest homes on the block.

One of the most challenging personal finance issues we all face is the ever-expanding definition of “need.” Things we once considered clear luxuries have somehow becomes necessities, often without any consideration of how the change in status happened.

Cars that seemed just fine now seem old fashioned. Then there are children and their cellphones. Only a few years ago it would’ve seemed outlandish for 14-year-olds to need one at all, let alone the latest iPhone.

Achieving clarity about the difference between our needs and wants remains one of the biggest challenges in personal finance and a tremendous source of potential conflict within families. While simple in theory, the calculation is much more complex in practice.

One of the most discouraging parts of modern life seems to be this never-ending sense that we should want more. While this may not be true for everyone, it does seem like it’s become more difficult to be content with what we have. Whether it’s the media, our friends or even our family, it can be a challenge to separate real needs from wants. So here are a few of things to think about:

• What if financial happiness is not about getting more but about wanting less?
• What if things start out as wants and become needs not because the thing itself has changed but because our feelings about it have changed?
• What if you can never really get enough of something that you don’t need?

From personal experience, I know that the shiny new toy I just had to have often ends up in a pile of things that I eventually need to sell on eBay. I’m not the only one that’s fighting this battle. It’s yet another example of why personal finance can be so complex. Because there’s no definitive list of the 100 things that every family must have, these end up being very personal decisions

I’ve talked about some of the ways I’ve seen people look for balance between wants and needs. They include things like sleeping on a decision overnight. My personal rule is that before I buy a book, it has to sit in my Amazon shopping cart for five days.

What have you done to help better define the difference between a want and need? And how have you focused more on being content with what you have instead of always striving for what you think you want?

The Ever-Shifting Balance Between Resources & Dreams

(from Carl Richard's New York Times' Bucks blog, 9/20/2011 - click here for the original post.  Carl  is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)

Most of us have limited resources, like time, money, energy and skills. At the same time, we have needs, goals and dreams. All too often they exceed the limited resources we have, so balancing these two areas of our personal economy can be tricky. We also need to understand that over time both of these circles change.

Sometimes the resources we have will be greater and allow us to do more of the things we want. Other times our needs and wants will seem to dwarf the limited resources we have to throw at them.
But it’s not something that we decide once and then check off the list. It’s a challenge we have to revisit regularly. So here’s how to think about both of the circles.

First, we need to stop focusing on things outside our control. When we do that, we miss opportunities during both good times and bad (like now) to find our financial balance. Don’t put off making important and necessary adjustments, because no one else will do it for you.

Second, we need to be honest about whether our goals are realistic given our resources. You may want to retire at 50, but if you haven’t been saving money regularly, that’s not likely to happen. Aim for things that really matter to you, but don’t set yourself up to fail before you ever start. Remember: your goal is maintaining balance, not achieving perfection.

Finally, look for new ways to make the balancing act work for you. Only you know your goals and only you understand what resources you can dedicate to achieving your dreams. Get the help you need to figure out the details, but it’s up to you to keep these two areas in balance.

It’s amazing the changes that I see in people once they figure out how to match their dreams with their resources. They worry a lot less day to day about things they have no control over. They spend more time with the people they love and doing things that make them happy. Even if their balance between resources and goals doesn’t look like anyone else’s, it’s still getting them where they want to go.

And that is all that matters.

What Do We Do Now?

Let’s get up to speed first

Last week, Congress & the White House came to a zero-hour agreement to raise the debt ceiling, covering the nation’s short term debt needs.  While there were some cuts made in future spending, the greater challenge of creating long term, meaningful solutions was left to a Congressional committee, charged with presenting a deficit reduction bill to Congress by Thanksgiving.
Friday evening Standard & Poor’s, an agency that rates the quality of various securities, debt obligations, governments and other entities reduced its rating of the U.S. government’s long term debt from its highest rating tier, AAA to the second highest rating tier, AA+.  There are varying opinions as to the validity of this decision, whether it was warranted or not and what it truly means for the economy, both in the U.S. and abroad over the long term.  Standard & Poor’s ultimately felt the current plan for reducing the debt is far from sufficient and that it needs to see more action from the government before improving their outlook.  As of this writing, the other ratings agencies have held the United States’ AAA status, but have warned that they, too, are concerned.

The world markets responded to these events in a very negative fashion on Monday, speeding up some already brisk downward moves from the week prior due to continued tension in Europe and slower than expected growth in various sectors here in the U.S.  Tuesday, the Fed released a statement confirming that interest rates will likely stay put for the foreseeable future.  Along with some positive corporate earnings, this news drove the market up nearly 4% and the Nasdaq up more than 5% on an extremely volatile trading day.

We continue to believe that the best defense in any market is to have a broadly diversified, low cost portfolio that is thoughtfully rebalanced to track with our client’s long term goals and tolerance for risk.  That said, we wanted to take this opportunity to provide our view on some commonly asked questions surrounding recent events. 

Are my cash & short-term bond funds safe?

In a word, yes. The money market funds we utilize are of very high quality and will continue to provide safety and security for our clients’ cash reserves.  Much the same, the remainder of the fixed income side of the portfolios, while subject to market fluctuation, are all short term, high quality bond funds.  Using these tools helps protect our clients from a number of factors.  For example, the debt downgrade impacts long term U.S. debt, but its short term rating has remained unchanged, meaning the impact of the S&P downgrade is likely to be minimal.

What can we do?

For most of us, the option to pull out of the market is the worst possible scenario, as can be illustrated by the late afternoon rally on Tuesday.  We will take action by continuing to look for opportunities to buy low and sell high as the volatility provides rebalancing opportunities.  Sticking with our long term discipline served us very well in 2008 and 2009 as the purchases we made during the worst of times have produced the strongest returns since.

While this sometimes feels like a “do nothing” response, it isn’t.  The truth of the matter is, to quote author and financial planner, Carl Richards, “The time to prepare for a crisis is long before you find yourself in one.  It’s not a good idea to figure out how a parachute works after you jump out of the plane. Financial plans and asset allocation models are built for the long term. Large fluctuations in market value are expected and are necessary as the downswings provide the buying opportunities that we’ll take advantage of in future upswings.  How one responds to these temporary fluctuations over a lifetime of investing is what really tests us as investors.

This is the first time the U.S. debt rating has been downgraded.  Is this time different?

No. While the look and feel of this crisis has different characteristics of the prior crisis, which had a different look and feel than the one prior to that, these issues, while incredibly painful and emotional, tend to appear and behave like most financial crises in hindsight.  They are part of the natural economic cycle of booms and busts, the constant battle between fear & greed.
Corporations around the world continue to collectively be healthier than they’ve been in quite some time.  Many are sitting on larger than usual cash reserves and earnings have remained strong overall.  Famed economist Burton Malkiel recently said, “Panic selling of U.S. common stocks will prove to be a very inappropriate response...no one can tell you when the stock market will end its decline, but there are some things we do know.  Investors who have sold out their stocks at times when there have been very large declines in the market have invariably been wrong.”

Who should I be reading? What should I focus on?

The best answer is that you should be reading your favorite books and magazines, and focusing on that which you can control and enjoy.  If this current economic situation fits that bill, below are some excellent articles that help breakdown what has occurred of late and a variety of responses.

Resisting The Urge to Run Away - Ron Lieber, New York Times, August 5, 2011

Your Neglected Stock Market Backup Plan - Carl Richards, New York Times, August 8, 2011

Don’t Panic About the Stock Market – Burton Malkiel, The Wall Street Journal, August 8, 2011

This crisis will come and this crisis will go. The same goes for the upswings. When they will occur is something that no one can tell you with any degree of accuracy, certainty or consistency. It’s tough to feel positive in the midst of so much uncertainty, but take solace knowing that if you stick to your disciplined plan and stay focused on long term results, you’re prepared.

Chip Workman, CFP®
cworkman@taaginc.com
http://www.taaginc.com/

When Television Feeds the Urge to Trade

(from Carl Richard's New York Times' Bucks blog, 6/6/2011 - click here for the original post.  Carl  is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)

Traveling last week, I shared some workspace where CNBC played all day on television. For most people, I realize that it’s often comforting background noise. However, since I almost never watch television, I found it amazing how bipolar I felt as they shifted from one commentator to another.

Given how wild the markets were last week, I imagine that there were many people tuning in trying to figure out what to do. And that’s the problem.

Watching CNBC might be entertaining, but unless you fancy yourself some sort of day trader, it will not help you figure out what to do with your life savings.

This won’t apply to all of you, but I’m going to make some assumptions here. I assume that for most of us the purpose of earning money, saving it and actually doing financial planning is to hit some sort of goal. I’ll also assume that those goals are typically things like getting out of debt, establishing a rainy-day fund and saving for retirement or college for kids.

If that’s true, what are you going to learn from watching hours of endless chatter about new-home sales or the jobs report that will be helpful in meeting those goals?

Things change so fast, and on television the reactions in the markets are amplified by the need to have something to talk about to keep everyone watching so they don’t miss the latest breaking news. This constant stream of information makes us feel like we should be doing something.

But the question is, what?

What should we be doing? What changes should we make based on the latest breaking news? Do you see the potential problem? If we’re tuning in to figure out what the latest news means for our investment plans, and we make changes based on what we hear … well, that’s an awful lot of changing.

Doesn’t it make much better sense to design our investment plans based on our goals, and then make changes when those goals change, instead of trying to react to the minute-by-minute updates? The only thing we know for sure is that things will change. Does your financial plan help you weather these changes or are you tempted to jump every time a new headline pops up on television?

The Best Investment Advice: Stop Losing Money

(from Carl Richard's New York Times' Bucks blog, 5/9/2011 - click here for the original post.  Carl  is a certified financial planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)




I’m more convinced than ever that Mark Twain was correct when he decided that he was more interested in the return of his money than the return on his money.

A couple of weeks ago, we discussed how often people in their 60s and 70s say that their primary residence of over 30 years was their best investment. This belief exists despite the fact that home values barely kept pace with inflation. How can this be, given that during the same time period average annual returns in various stock market indexes ranged from 8 to 13 percent?

Because for most people, it was the only investment that didn’t lose money!

While the same outcome may not apply to housing in recent years, the principle still applies to investing in general. Most of us are chasing the highest return, because that’s what investing is all about, right?

But the experience of many people has been that the well-intentioned search for the best investment actually cost them money. They bought at the peak and sold at the bottom, and their overall returns ended up being meager. I suspect lots of these people would gladly trade their actual experience over the last decade or more with simply having their money returned to them.

So, what if the key to investment success is to start by making sure that you don’t lose money? Could it be that accepting a lower rate of return might result in having more money than continuing the wild goose chase of this magical 10 percent we hear that the stock market delivers over time?

Part of the problem is that we focus on the wrong thing, like finding the very best investment or beating a particular stock market benchmark. Both are a wild goose chase. Having the money for a dignified retirement, however, is not. By setting real financial goals, we can quit chasing investment performance and focus instead on creating a plan for the future that makes sense.

Once a plan is in place, it may very well be that the best thing we can do with our investments is to simply not lose money and take the time and energy we were spending in the chase and focus on those things that we have more control over. Things like finding creative ways to earn or save more, or just enjoying the one life we have to live.

Confronting Your Personal Debt Ceiling

(from Carl Richard's New York Times' Bucks blog, 4/18/2011 - click here for the original post.  Carl  is a certified financial planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)

We’ve all made financial commitments like mortgages, rent payments, college tuition and utility bills. When you combine those commitments, you end up with the foundation for a budget. But what happens when those commitments exceed your income?

After we become accustomed to a certain lifestyle, it can be difficult to make adjustments when the amount of money coming in decreases. But unlike the federal government, real people don’t have the option to take a vote and raise their personal debt ceiling. In the real world, increasing your personal debt ceiling only works for so long. At that point, there are only two options:

1. Earn more
2. Spend less

Simple math, tough choices.

Yet again we have another example of how painful it can be when the cold, hard facts of arithmetic smash against the complex, emotional issues of money. The math is simple: if you spend more than you earn, at some point things will have to change.

But once we move beyond the math, things start to get fuzzy fast. Most of us can relate to that sick feeling of comparing what we owe to the amount of money sitting in the bank and knowing it isn’t enough, or the pain of telling children that we simply can’t afford to do something that was incredibly important to them or the awkward discussion with a spouse about which extra expense we have to cut to make ends meet. These conversations aren’t easy, but they have to happen if we want things to change. At some point we can’t continue to kick the can down the road.

To add to the frustration, these decisions are intensely personal. We all want easy answers from some personal finance guru who will tell us what to do. We want a prescription, but this discussion doesn’t work that way.

Sure, there are books that will provide a framework, and learning from others (including Elmo) that have been through this can be helpful. But in the end, your situation is absolutely unique. It will require you to come up with a plan that works for you. Often what one family defines as a need another will view as a luxury, and neither one of them is wrong. In the end, they will both need to satisfy the equation on the napkin: their income must be greater than or equal to their expenses.

At some point in your life, you’ve done the math and realized that your financial commitments were out of whack with your income. How did you fix your problem? If you have children, how are you helping them understand the need for financial balance?

Don't Confuse the Urgent with the Important

Carl does a great job in the blog below of reminding us of why those things with low urgency, but a high degree of importance on our to-do list deserve our time and attention before it's too late.  

(from Carl Richard's New York Times' Bucks blog, 3/21/2011 - click here for the original post.  Carl  is a certified financial planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, BehaviorGap.com.)
  

Last weekend marked the beginning of spring, and even though there’s still snow on the ground here in Park City, it reminded me that nearly a quarter of the year has come and gone.

Like many of you, I made resolutions in January. There were a lot of important things I wanted to accomplish. And for a few weeks, I did really well. But now it’s March, and part of me is panicked. There’s still so much to be done. But another part of me latched on to the second half of the equation: I still have three quarters of the year to go. What’s the big deal?

The problem results from the distractions that come from things that seem urgent. They cause us to lose our focus on the important issues.

On a day-to-day basis it’s easier to focus on those urgent things that capture your attention. After all, who wouldn’t focus on getting the car fixed over making sure the will is up to date? That seems like a logical decision that trumps the merely important goals you set in January.

Bob Goldman, a financial planner, said that he sees a surge in business around January and February. So at least they’re trying.

But Mr. Goldman added that he often doesn’t see those people again for years. Following through on the big decisions tends to  drop down the list quickly when you’re confronted by life’s urgent demands. After all, many of these important goals appear complex, like buying life insurance or setting up college savings accounts. So we often push them aside in favor of the urgent and immediate.

Plus, we enjoy the sense of checking urgent things off a list. The more urgent the task the greater the sense of satisfaction. By comparison, sitting down and working through the details of your personal and financial lives doesn’t offer the same sense of excitement and immediate gratification.

Here’s the danger in all of this though. Once time passes, the important eventually becomes urgent. But by then it may be too late to do much about it.

Think about the stories of friends and colleagues who are dealing with complicated estates because family members let the urgent trump the important. Then there are the parents who didn’t think 18 years would pass so quickly; now they’re unsure whether they can help pay for college.

A friend who is an estate planning attorney noted that people will often come to him in a panic right before taking a trip without their kids. With worst-case scenarios floating through their minds, these couples want their wills done in case the plane goes down or the ship sinks. Since these things take time, it’s often impossible to finish before they leave town. Then, my friend doesn’t hear back from them again until a few days before the next trip.

See a pattern here?!

If there’s one resolution that I hope each of you keeps it’s this: please set aside time each month to tackle these important questions. Yes, you will be tempted to brush them aside until next month because there will be something urgent going on. But you can’t keep making the same resolution every January to deal with your important decisions this year. The tasks will never get smaller if you don’t start dealing with them one by one.
After every financial crisis we often ask, “How did we miss the signs?” Unlike a large-scale crisis that only seems obvious in hindsight, you know that you can prevent a personal financial crisis by tackling the important tasks in your life right now.

The Danger of Stock Market Forecasts

(from Carl Richard's New York Times' Bucks blog, 1/10/2011 - click here for the original post)

Carl Richards is a certified financial planner in Park City, Utah. His sketches are archived here on the Bucks blog, and other drawings are available on his personal Web site, BehaviorGap.com.

January marks the time of year where gurus come out of the woodwork with their stock market forecasts.

I thought it would be valuable to review a few of them and try to understand what they might mean to real people investing in the real world. I’ll cover two recent forecasts and one from a few months ago, too.

Let’s begin with Robert Prechter. In July, 2010, he said that based on his version of something called the Elliott Wave principle, “the Dow, which now stands at 9,686.48, is likely to fall well below 1,000 over perhaps five or six years as a grand market cycle comes to an end.” Since then, the Dow has been up sharply.

Then we have Robert Shiller of Yale. He recently put his price target for the Standard &Poor’s 500-stock index at 1,430. (At this writing, the index is currently about 1,280.) Before you get too excited, note that Mr. Shiller says that his prediction is for 2020. That works out to less than a 1.5 percent increase a year for the next decade!

Finally, there’s Laszlo Birinyi. According to a recent Bloomberg Businessweek article, Mr. Birinyi believes the S.&P. can hit 2,854. And in an amazing display of precision, he predicts this will happen on Sept. 4, 2013.

So there we have it. Three market gurus with three wildly divergent forecasts that were all covered and reported by reputable, mainstream news outlets.

What’s a real investor to think or do?

The problem with gurus and their guesses is not that they’re always wrong. Part of what makes these forecasts so tempting is that the gurus are right just often enough for us to believe that there’s merit in listening. Unfortunately, it’s incredibly difficult to identify which forecast will be right.

So what does a real person do with this information? I suggest you use it as kindling, as a starting point. I know it’s fun to chat with friends or colleagues about your opinion of the stock market. I also know it can feel like the duty of any self-respecting American to have an opinion about the market and the economy.

Having an opinion is fine. But acting on it with real money is often incredibly damaging. To move beyond opinion you can start by doing the following:

• Realize that investing is a means to an end and not the end in and of itself. Take the time to define the end (your goals), and realize that good investment decisions are only made within the context of your life.
• Once you define your goals, figure out what it will take to get you there. Part of that will obviously include a rate of return that you need to achieve. If that rate of return is unrealistic, then make adjustments to your goals. For example, you can try to save more, you can spend less or you can delay goals like retirement.
• Once you have a realistic set of goals, build the most conservative investment strategy you can to get you there.

You need to realize that no one can tell you with any sense of precision where the stock market (or any market) is going. If you’ve learned nothing else during the last 10 years, I hope you remember that the stock market won’t perform in a set way indefinitely. At some point the market will go down, and it may be for a long period of time.

Just as likely, the market will often go up a lot over a long period. So for the real investors who are investing real money in the real world, take note that you should build your investment strategy around your life and your goals and not the annual guesses of gurus.

Seduced By Complexity

(from Carl Richards' newsletter Behavior Gap, 10/28/2010 - click here to link to the original post)

Why do we say we want simplicity and then chose complexity? It often starts when we get caught in the trap of two competing stories. In the first one, we tell ourselves we want to simplify, simplify, simplify. In the second story, we tell ourselves that the solution to an important problem has to be complex. The reality is that getting something simplified is the ultimate form of sophistication, so why don’t we choose simplicity when it comes to financial planning? Even though people list simplicity as their number goal on survey after survey, we still seem to opt for the more complex solution because complexity can appear easier on the surface.

Too many times, I’ve seen people disappointed when I’ve proposed a simple solution to their investment or financial planning problems. Often the solution can be reduced to a simple calculation on the back of a napkin, but clients somehow take comfort from a 100-page paperweight packed with a thousand calculations. Logically they know that complexity isn’t a guarantee, but it seems to make people happy.

Pleasure in complexity even shows up in emergency rooms, too. According to a physician friend, patients are often disappointed when the diagnosis is relatively simple like, “Go home and get some rest,” or “Stop smoking and eat a little less junk food.” The patients appear to hope for a terminal disease because it’s “easier” than going home and following simple, but hard, health rules.

We spend $40 billion a year on weight-loss programs and products even though we know that for most of us the answer is simple, but difficult. It comes down to either consuming fewer calories, burning more calories with exercise, or both. But it’s tempting and far more interesting to look for complex solutions that appear easier, but aren’t effective.

What part of human nature attracts us to complexity instead of a simple solution? Maybe we’re counting on a magic bullet, something to save us from the simple, but often hard work. Maybe debating complexity is more fun than the day after day grind of just getting the work done. We even have a tendency to believe that complexity is a sign of intelligence. In reality, the simplest solution almost always turns out to be the most effective, but also the most difficult.

One example in a recent Reuters article highlighted a family that put their kids through college with no debt. They managed it on a modest family income by driving the same car for 10 years and putting money away month after month. The author asks, “Is this a fairytale?” If it is, then we’ve forgotten the basic tenants of financial success. Based on my experience boring, simple things like saving money, avoiding speculative investments, and repeating that process over and over isn’t sexy or appealing.

We need to understand our attraction to complexity because it impacts the way we approach our financial goals. The reality is that the simple options with the largest impact on your financial success can be difficult to implement. They require discipline, patience, and hard work. And they require that we apply those basic, fundamentals over and over for years. It's much easier to entertain ourselves with the thought of finding an investment that will give us a fantastic return than to save a little bit more money each month.