Great news about investment accounts

Every adviser understands the primary threat to investment success isn’t the investment style. It’s not the assets chosen, nor the allocations made. It’s not the business cycle. It’s not even picking the right or wrong money manager or adviser, as long as they understand this basic principle. All these things are important, but they aren’t what submarines most investments and retirement plans.

The Good News

Dalbar Inc., the financial community’s leading independent expert for evaluating investor performance, is a Boston-based company that every year releases its annual study, “Quantitative Analysis of Investor Behavior” (QAIB). For the past quarter century, its findings have been consistent and eye-opening. For the past 25 years, Dalbar has reported that the average investor receives on average about a third of the returns generated by the market. In other words, if the average investor would just put their money in the market and leave it, the return would be, on average two to three times greater. So, the primary threat to your investment success is…you.

This is good news. In fact, it’s great, marvelous, wonderful news. It’s the best news you could hope for, because of all the forces that can impact investing success or failure, the only one you have any control over at all is…you. Put another way, you actually have control over the number-one threat to the success of your retirement.

But do you? The fact is, we are hardwired to be bad investors. We are programmed to flee from and react when threatened, and to jump in when opportunity strikes. Unfortunately, this is exactly the opposite of good investing. Perhaps best characterized by Baron Nathan Rothschild, an 18th century British nobleman and member of the Rothschild banking family, who is famously credited with saying that “the time to buy is when there’s blood in the streets.” But that’s not the whole story. The original quote is believed to be, “Buy when there’s blood in the streets, even if the blood is your own.” He would know; Rothschild made a fortune buying in the panic that followed the Battle of Waterloo against Napoleon.

Unfortunately, this is something that is very risky and difficult to do, especially with something as important as retirement savings. Generally, people want to set up their accounts so regular contributions are made and then forgotten about. Since this is beneficial to the financial industry, they are encouraged to do so by employers, plan administrators, and financial advisers. This often works until market swings fall outside one’s tolerance. When these swings are significant enough to notice, overreaction often follows. And that’s when the challenges uncovered by Dalbar arise.

The Status Quo

The key to investing success is to find your risk tolerance and align your investments to match it. That’s not new; advisers have been using a version of this for years. Unfortunately, the old subjective risk questionnaires almost always miss the mark. That’s because the traditional way of assessing risk–pigeonholing investors into broad categories like “conservative,” “moderate,” or “aggressive”–simply doesn’t work; average market volatility is often far greater than just three black and white categories. Instead of finding the right level of risk, these methods identify what’s closest, and quite often, close is just not good enough to alleviate investor uncertainty.

That’s why we use a system called Riskalyze which precisely identifies a value called the Risk Number®. How is this different? First, the Risk Number® ranges from 1-100, providing a much more accurate assessment. Second, it’s built on a Nobel Prize-winning framework that can quickly identify a person’s risk tolerance with pinpoint accuracy. All it takes is a quick five-minute quiz to identify your risk number.

Next, you line up your investments so they match your risk tolerance. Done correctly, these steps will ensure that your portfolio will deliver expected results 95% of the time. When you get expected results, it’s easier to not make dumb decisions.

But what about the other 5% of the time? Well, that’s when your investment policy takes over, also protecting you from yourself. Without a stated investment policy, you are flying by the seat of your pants, and that’s what gets you in trouble. When you do have an investment policy, you just follow the policy, keeping emotions out of the decisions.

Imagine the relief you will feel when your valuable retirement accounts do exactly what you expect 95% of the time, and you have a plan to employ proven techniques the other 5%.

Stephen Kelley is a recognized leader in retirement income planning. Located in Nashua, he services Greater Boston and the New England areas. He is author of five books, including “Tell Me When You’re Going to Die,” which deals with the problem unknown lifespans create for retirement planning. It and his other books are available on Amazon.com. He can be heard every weekend on “The Free Money Guys Radio Hour” on WCAP and WFEA, and he conducts planning workshops at his New England Adult Learning Center, located in Nashua. Initial consultations are always free. You can reach Steve at 603-881-8811 or at www.FreeToRetireRadio.com.