Reversion to the Mean

Posted On October 19, 2015 By Admin In Behavioral Finance /

One of the more counter-intuitive financial concepts to embrace is reversion to the mean. Markets tend to behave in fairly consistent ways over the long-term. Wharton Finance Professor Jeremy Siegel examined 200 years of stock market returns and found that the average after-inflation rate of return of stocks, in all periods, was between 6.5% and 7.0%. This phenomenon has been named “Siegel’s constant” by economists. Even though the market can be down for 1 year or even 10 years, when we look at longer periods of 20 or more years, real returns have been remarkably uniform.

Investors are rewarded for their patience because returns do revert to the mean. This is an easy concept to understand, but the resulting decisions are often difficult to embrace, because they often require doing the opposite of what is currently working. When the tech sector was booming in the 1990’s, Blue Chip dividend stocks lagged, but that is precisely what you should have been buying in 1999 to avoid the subsequent meltdown in the over-valued tech stocks. This is obvious in hindsight, but at the time, it was very difficult to choose a lagging value fund, when you could have put your money into a hot sector fund that had returned 50% or more in the previous year.

One of the easiest ways to use mean reversion to your benefit is through rebalancing. When our positions deviate by more than 10% from our targets, we trim what has out performed and we purchase what has under performed. Besides helping us maintain our target allocation and risk profile, rebalancing can be beneficial by buying what is out of favor when it is on sale. The same benefit occurs when you dollar cost average in a volatile or declining market, or when you reinvest dividends over time.

A number of years ago, an analyst from Research Affiliates was visiting Dallas and dropped by my office to share a recent white paper they had produced on factors effecting index performance. They ranked stocks by factors such as momentum, and then tracked the performance of the stocks with either high or low momentum. Strangely, both the high and low momentum segments had a better long-term number the overall Index. At first, I thought this must have been a mistake, thinking both halves should equal the average of the whole index. But what was actually occurring was that the ranking process was in effect an annual rebalancing, dropping stocks from that segment when they peaked (in the high momentum category), and then adding them when they were out of favor (to the low momentum category). This annual rebalancing was actually a significant driver of investment returns.

The counter-intuitive part of rebalancing is that instead of buying what is working, you must buy what is lagging. This works for broad asset classes, but you should not apply this approach to individual stocks, lest you buy more of the next Enron. Stocks can go to zero, but categories do not.

And that brings us to today’s market. With volatility spiking in the third quarter, we have leading and lagging segments for 2015. Here are three categories of special interest today, in terms of reversion to the mean.

1. Growth continues to outperform value in 2015. Through October 16, the iShares S&P 500 Growth (IVW) is up 3.53% while the S&P 500 Value (IVE) is down 3.27%. The Growth ETF outperformed the Value ETF in 2014, 2013, and 2011. Over the past five years, the annualized return on the Growth ETF is 14.88% versus 12.52% for the Value ETF. Historically, Value outperforms Growth, and that is the case over the past 15 years for these two ETFs. Currently, Growth is in favor, but I think the smart approach for investors is to believe that the returns will be mean-reverting, and we will eventually, if not soon, see Value return to favor. Currently, Growth is benefiting from high returns from tech and health care sectors, which appear to be getting frothy. Value is being held back by energy stocks, which have been very weak this year. Our approach: we own a broad market index (iShares Russell 1000) which has both Growth and Value segments, plus we own a Value fund with a terrific long-term record of good risk-adjusted returns.

2. Emerging Markets have lagged Developed Markets. Through October 16, the Vanguard Emerging Markets ETF (VWO) is down 6.82%, compared to the iShares Russell 1000 (IWB) which is up 0.20%. The Emerging Markets ETF was also down in 2014, 2013, and 2011. Why would we want to hold such a perennial loser? Mean reversion, of course. While EM is currently out of favor, those stocks are becoming cheaper and cheaper while developed stocks are becoming increasingly expensive. Let’s look at a couple of metrics: for VWO, the Price to Earnings ratio is 11.75 and the Price to Book ratio is only 1.46. US Stocks (IWB) are much more expensive, with a PE ratio of 17.16 and a PB ratio of 2.26. The more concerned you are about US Stocks, the more you should want to own EM stocks. So despite a very difficult Q3 for Emerging Markets, we will continue to own the segment and will rebalance as needed in portfolios.

3. High Yield Bonds are down. The SPDR Short-Term High Yield (SJNK) is down 1.88% through October 16, while the Barclays Aggregate Bond Index is up 1.56% to the same date. As the price of high yield bonds declined this year, yields increased and the spread over Treasury bonds has widened, offering a better risk/return profile than previously. The yield on the 10-year Treasury remains around 2.1% today, while the SEC yield on SJNK has increased to 6.81%. But this is more like a series of popular online friv games than what is described above. That’s not to suggest that high yield bonds are risk-free, but the mean reverting approach suggests that the sell-off in high yield presents an opportunity relative to Treasuries.

Understanding the reversion to the mean is crucial for investors to offset the behavioral influence of recency bias. Recency bias is the natural tendency to mentally overweight the importance of recent events and to disregard a more rational decision making process. For example, if a coin turns up “heads” four times in a row, people are more likely to assume that the streak continues, even though the chance of the next coin toss remains 50% heads and 50% tails. The more coin tosses you make, the closer you will get to 50/50 over time. That’s mean reversion. If you understand this concept, you are less likely to make the mistake of assuming that last year’s hot sector, fund, or stock is the best place for your money today. Instead, you’ll realize that rebalancing is a smarter process than chasing past returns.

Data from Morningstar, as of October 18, 2015.

Behavioral Tricks to Improve Your Finances

Posted On September 28, 2015 By Admin In Behavioral Finance /

I was saddened to hear of Yogi Berra’s passing last week. One of the great quotes attributed to him is “In theory, there is no difference between theory and practice. In practice, there is.” I’ve always thought this quote applied well to personal finance, where the academic expected behavior could differ significantly from the choices people make in real life.

The fact is that we all use our feelings, intuition, and past experience to make our decisions as much, or more, than we rely on logic, research, or an open-minded examination of evidence and data. Many academics take the view that any behavioral deviation from the theoretically optimal decision will lead to poor outcomes. And while that is definitely the case in many situations, my observation as a practitioner is that even the most successful individuals are not immune from this “irrational” behavior.

My point is that when theory and practice do deviate, there can still be good outcomes, in fact, sometimes even improved outcomes. Here are six ways you can use behavioral concepts to improve your financial situation. In theory, these won’t help. In practice, they will.

The 15-year mortgage. In theory, you can make more in stocks than the interest cost of a mortgage, so you should get an interest-only loan and never pay it off. Home values generally appreciate over the long-term, and there is no additional benefit to having equity in your home. Although this is theoretically correct, I suggest that home buyers get a 15-year mortgage instead of a 30-year or interest only note. The reason that the 15-year mortgage benefits buyers is that it will force you to buy a lower priced home to be able to afford the higher monthly payment. If you start your house hunt with a 15-year mortgage in mind, it might mean looking for a $300,000 home instead of a $350,000 home. The lower cost home will have lower property taxes, insurance, utilities, and other costs. More of your monthly payment will go towards principal with the shorter loan, so you will build equity faster, which is very valuable if you should need to move after five or ten years. Having a higher monthly mortgage payment will also force you to save more. By that I mean that if you had a payment that was $500 less, you probably would not save an additional $500 a month; you’d probably save only a small part of this, maybe $100 or $200 a month, and increase your spending by $300 or $400.
Set up your 401(k) contributions as a percentage. People are shockingly lazy with their 401(k) accounts. Many never change funds, and even more never change their contribution level. If you set up a $100 contribution per pay period, chances are good that five years later you are still contributing $100. If, on the other hand, you established a 10% contribution, your dollars contributed would have increased with your raises, promotions, and bonuses. If you can, increase your percentage contribution every year until you make the maximum allowable contribution, $18,000 for 2015.
Make it automatic. We are creatures of habit and momentum and will seldom change established our course. If you give someone $100,000 to invest, they will agonize over the fund choices and try to time their purchases. If the market goes down, they’ll bail out and blame the fund or the manager or something else. It’s better to set your investing on auto-pilot, invest every month into your 401(k), IRA, 529 college savings plan, or other investment vehicle. And then do what is natural for most of us: nothing. Keep investing when the market goes down. Stick with a basic, diversified allocation. That’s why people who have a created a $100,000 account by investing $1000 a month are more likely to stay on course than the investor who puts in a lump sum. Already have your investing on cruise control? Take the next step and make your rebalancing automatic, too!
Pay cash for cars. In theory, there’s nothing wrong with financing or leasing cars. However, if you get in the habit of paying cash for cars it will change your behavior for the better. It is incredibly painful to write a $35,000 check for a vehicle. If you pay cash for cars, it will force you to keep your current car for longer while you save for the next one. It will make you consider a used car or a lower cost vehicle. And it will be a strong incentive to keep your next vehicle for a very long time. Cars are often our second largest expense after housing. Most cars lose 50% of their value in five years, so would you prefer to lose half of $75,000 or half of $30,000? People don’t think this way when all they know is their monthly payment. When you pay cash for a car, you start to think like an owner and not a renter.
Do less research. One of the mental biases facing investors is overconfidence; the more research we do, the more we believe we can predict the outcome of our investing choices. This can lead to people being overweight in their company stock, getting in and out of the market, or making large sector bets. These choices often lead to increased risk taking and quite often to long-term under performance. We’re also likely to suffer from “confirmation bias”, where we cherry pick the data or articles which corroborate our existing point of view and ignore any contradictory evidence. Overconfidence and confirmation bias don’t just affect individual investors, they are significant challenges for professional fund managers. Since the majority of professional managers cannot beat the index, I don’t hold much optimism that an individual can do better. So, cancel your subscription to the Wall Street Journal, turn off CNBC, and buy an index fund.
Use “mental accounting” to your advantage. Money is fungible, meaning $1 is $1 regardless of where it is located. However, people like to divide their money into buckets for retirement, saving, spending, emergency funds, college, vacation, or whatever. In theory, this is meaningless, you’d be equally well off with just one account invested appropriately for your risk tolerance. Even though Academics would like to banish mental accounting, people are enamored with their buckets. While you should look at all your holdings as being slices of one pie, you can use mental accounting to your advantage. You are less likely to touch money when it is in a dedicated account. For example, if you put money in a savings account for emergencies, you may later be tempted to spend that money on a vacation or other splurge. If you instead put that money into a Roth IRA, you’d be much less likely to touch it. But if you did have an emergency, you could access the principal from your Roth, tax-free. The other benefit of buckets is that it may force you to do more saving when you have specific dollar goals for retirement, college, or other purposes. Then if you need to plan for a vacation, you know you will have to do additional saving and cannot touch the buckets allocated for other goals.

Use behavior to your advantage by making sure your choices are helping you get closer to achieving your goals. Investing can be simple; it’s people who choose to make it complicated. Stick to the basics and stay focused on saving and diversification. I’m not sure we can ever completely remove behavioral biases from our decision making process, but the more we are aware of those biases, the easier it is to step back and recognize what exactly is driving our choices.

Win by Avoiding These Mistakes

Posted On June 8, 2015 By Admin In Behavioral Finance /

This week, I heard an orchestra conductor say, “It’s not simple to make it sound easy.” While he was talking about music, I was thinking how this applies to investing, too. The more we know about investing and the more experience we have, the more we recognize the benefits of following a very straightforward approach. You don’t have to be a genius to be a successful investor, you just have to avoid making a couple of big mistakes. The game of investing is not won by brilliant moves, but rather by patience and avoiding the common pitfalls that lure investors in year after year.

It’s easy to recognize mistakes in hindsight. The challenge is to anticipate these outcomes in advance, so you can prevent these these errors whenever you are tempted to make changes to your portfolio. Is your decision based on a logical examination of the facts, or an emotional response or ingrained bias? You can be successful over time by following a smart plan, even if it is not complicated. Let the market run its course and know that your plan will work best when you don’t get in the way! Here are three of most costly mistakes I’ve seen investors make in the past 15 years and the solution for you to avoid these each of these missteps. These are real, actual people, but I’ve changed the names here to protect their identity. Learn from their losses!

1) Lack of diversification. 10 years ago, I met Peter who was a client of another financial advisor at my firm. Peter was an engineer at Nortel, and like many employees at tech companies in the 90’s, he received substantial stock options. For years, the stock would double and split every 18 m0nths or so, which meant that anyone who sold their stock options regretted not holding for longer. Peter had more than 12,000 options when Nortel hit $90 a share in the spring of 2000, giving his options a value of over $1 million. At every meeting, they discussed exercising his options, selling his shares and diversifying, but Peter wanted to wait longer. The stock fell to $85, and Peter finally agreed to sell, but said that he had his heart set on a higher price and would sell as soon as it got back over $90 a share.

Unfortunately, the stock never regained the $90 level, and instead lost 90% of its value over the next nine months. His options were now worthless and his hopes of retiring in his 50’s lost forever. Nortel went bankrupt in 2009 and his division was sold to competitor. Peter had the majority of his net worth in company stock and the loss truly decimated his investment portfolio and derailed his retirement plans.

It is often said that diversification is the only free lunch in investing. By being diversified, you can avoid the risk of having one stock wipe out your plans. And I should mention that this also applies to bonds. I met another investor who had $100,000 of Lehman Brothers bonds for their portfolio. As I recall, I believe the investor recovered only about 25 cents on the dollar after the Lehman bankruptcy in 2008.

Solution: Don’t let company stock – or any single stock – comprise more than 10% of your portfolio. Even better, avoid single stocks altogether and use ETFs or mutual funds. For bonds, I’d suggest keeping any single issuer to only 1-2% of your portfolio. The potential benefits of having a concentrated stock position are outweighed by the magnitude of losses if things go wrong.

2) Trying to Outsmart the Market. Luke considered himself a sophisticated investor and enjoyed reading and learning about investing. He had an MBA and felt that with his knowledge and a subscription to the Wall Street Journal, he should be focused on beating the market. He looked at his portfolio almost every day and would be very concerned if any of his funds were lagging the overall market. As a result, he wanted to trade frequently, to put his money into whatever sector, fund, or category was currently performing best.

Funds typically include the disclaimer that “past performance is no guarantee of future results”, and yet, so many investors are focused on picking funds based on their most recent past performance. In Luke’s case, his insistence on “hot funds” meant that he was often invested in sector funds. His performance over time was actually worse than the benchmarks, because in spite of all his research and knowledge, he was focused on looking backwards rather than forwards.

Solution: stay diversified and don’t chase hot funds. Typically, 65% to 80% of all active managers under perform their benchmark over five years, which means that your safest bet is to never bet on a manager’s skill but to bet on the house. Using index funds works, and adopting an index approach means you can focus on what really matters for accumulation: how much you save. Luke’s portfolio was relatively small, under $100,000. Ironically, investors with smaller accounts are often the ones who believe that they need to outsmart the market to be successful. When I worked with a client with over $100 million, he had no qualms about index funds whatsoever.

3) Timing the Market. Angelina retired in 2007, a year before the stock market slumped. In early 2009, the market was down nearly every day, sometimes losing 5% in a session. We had conversations previously with Angelina about market volatility and had implemented a diversified, balanced portfolio. On March 6, 2009, Angelina called and insisted that we exit all her equity positions. It was that very day that the S&P 500 Index put in its intra-day low of 666. In hindsight, she sold on the actual worst day possible. Luckily, we were able to convince her to buy the equities back by June, but by then, she had missed a 30% rally.

Market timing mistakes aren’t limited to selling at a low; you can also miss out when the market is doing well. Last year, while the market was up double digits, some investors had significant capital in cash, fearing a drop or hoping to profit from any temporary pullback. Those with large cash positions under performed those who were invested in a target allocation. Having looked at hundreds of investors’ performance, I have yet to see anyone who has improved their return through market timing, except from random luck. Trying to get in and out of the market gives you more opportunities to make mistakes.

Solution: Choose an appropriate asset allocation and stick with it. Invest monthly into a diversified portfolio, and don’t stop investing when the market is down. If you think you will wait until you get an “all-clear” signal, you’re going to miss out on gains like Angelina. Rebalancing annually creates a discipline to sell your winners and buy the losers, which is difficult to do otherwise!

Investing should be easy. People have the best intentions when they load up on company stock, invest in a hot fund, or try to time the market. The reality, however, is that the more complicated strategy you adopt, the more likely you will hurt rather than enhance your returns. Our goal is to help investors gain the knowledge, confidence, and discipline to recognize that your most likely path to success is to stick with a simple approach that is proven to work.

Want to read more? Check out Winning The Loser’s Game by Charles Ellis.

Are We Heading For A Bear Market?

Posted On May 18, 2015 By Admin In Behavioral Finance /

Yes, we are headed for a bear market. But, that’s no cause for alarm, because there is always going to be another bear market. That’s how markets work – we have periods of economic expansion, followed by periods of contraction. I should add that I have no idea when the next bear market will occur, but if you’re wondering if a bear market will occur, then yes, it is 100% inevitable. You’ll be happier and a better investor if you accept this fact, too.

Today’s bull market will eventually run out of steam and we will have a bear market. And that will be followed by another bull market, and so on. The key thing to remember is that the overall long-term trend is up, and that bear markets are simply a brief interruption of a permanently growing global engine.

Since World War II, we’ve had roughly 13 bear markets (a drop of 20% or more), which works out to an average of once every five years. Each one of those bear markets felt like the sky was falling and that markets would never recover, but what has actually occurred is that the S&P 500 Index has expanded 100-fold from 19 in 1946 to 2100 today.

If you are just getting started investing, you might see perhaps 8 bear markets as you accumulate assets for 40 years. And if you are now retiring, you may experience 6 or so bear markets over a 30-year retirement.

It’s easy to agree that you won’t try to time the market when the market is doing great, like it is today. But even the steadiest investor is likely to have their resolve tested if the market goes down 20%. It’s human nature to want to stop the pain of losses and just get out of the market. Unfortunately, the moment of maximum pain will be at the bottom – exactly the worst time to sell your stocks.

With so much fear in the market today, some investors are wondering if we should sell and sit in cash until there is a decline. I can’t advocate this type of strategy. Even if you are successful in getting out of the market, you have to correctly get back into the market. I’ve yet to see any fund or firm be able to do this consistently over several economic cycles. And every study I have seen on individual investors has found that a market timing approach is likely to have worse returns than sticking with a buy and hold strategy.

Some so-called experts have been predicting a bear market for several years, and if you had sold your stocks based on their advice, you would have missed out on significant gains. Even after six years of positive returns, it’s possible that the bull market will continue to march upwards. No one has a crystal ball to predict how the market will perform in the short term. Market timing doesn’t work because it requires knowledge which doesn’t exist.

What we do know is that bear markets are inevitable and what really matters is how you respond to them. That’s why it’s vitally important to have a plan in place for that future storm while the sun is shining today. Here’s our plan and what you need to know about bear markets:

1) Bear markets are a brief interruption of a larger uptrend. If you’re a long-term investor, don’t worry about bear markets.

2) Don’t make a temporary decline into a permanent loss of capital by selling. Know that we plan to stay the course. We will not attempt to time the market. We choose an all-weather allocation which we will maintain in both bull and bear markets based on your needs, goals, and risk tolerance.

3) We rebalance portfolios annually. When the market is up, that means we trim stocks and add to bonds. If the market goes down, we will buy stocks when they are on sale. Remember that we are always highly diversified and avoid both sector funds and single country funds.

4) When you hear “Bear Market”, I want you to think of two words. First, inevitable, and second opportunity. When a TV is marked down by 20 or 30% off last year’s price, you don’t think its a disaster, it’s a chance to buy something you want at a lower price. Take advantage when the market puts stocks on sale.

Have faith in the future. Not a blind naivete, but an understanding of history and an appreciation for the opportunity which bear markets bring to us. The key question is not whether or not we will have a bear market, but if you are prepared and know what to do when we eventually do have one.

Adversity or Opportunity?

Posted On October 21, 2014 By Admin In Behavioral Finance /

In the past two weeks, market volatility has spiked and major indices have traded down 7% or more. I follow the market closely and monitor the situation for news which might impact our portfolios. Generally, I prefer to use this space to discuss beneficial financial planning topics, but I know that everyone is wondering about the market, so here is my take on the situation.

The recent pull-back has been relatively minor and probably long-overdue, given that we’ve gone five years since a significant correction. The good news is that stock fundamentals are strong and the US economic recovery remains in place, although actual growth is somewhat tepid. While equity prices have risen, valuations are within a normal range and not at the elevated levels we saw in previous bubbles. With interest rates remaining extremely low, “risk” assets like stocks still offer greater potential return than cash or fixed income.

Having shared my opinion, I have to say that it really doesn’t matter what I think will happen. Anyone who thinks that data is “proof” of what the market is going to do is fooling themselves. No one can predict the market. Fortunately, long-term investment success does not require a crystal ball. What it does require is a well-researched and executed plan, a diversified allocation, and most importantly, the fortitude and discipline to stick to your plan.

I was asked this week if I got my clients out of the market before the recent turmoil. No, I didn’t and I didn’t sell any of my own stock positions, either. I was doing the opposite this week: buying in a number of portfolios. And I was quite happy to have the opportunity to pick up ETF shares 5-10% lower than they cost just three or four weeks ago. I’m focused on the long-term opportunity and not the present adversity. Although I don’t know where the market will be one month from now, I strongly believe that the market will be significantly higher in 10 years from now and that is what really matters.

So rather than worry about the troubles of the day and the things you cannot control, I believe investors are best served by focusing on the things you can control, such as:

establishing a target asset allocation to match your risk tolerance, required return, and time horizon;
diversifying to eliminate company-specific risks;
keeping investment expenses low and reducing tax drag to a minimum; and
how much you save and invest.

Of these four, the last one is crucial to your individual success. The news tends to make us focus on trying to improve short-term investment performance, instead of how much you should be saving. If your goal is accumulation, it’s more important to be thinking about how to increase your saving than how to increase your return. We have to learn to ignore the noise of the daily media so we can stay focused on how to achieve our long-term objectives.

Optimism is key. Not a blind naivete, but the confidence to know that you are on the right path, and the recognition that sometimes the path is uphill. I remember a bit of wisdom I heard years ago “You make your money in bear markets, you just don’t know it until later.” If you’ve got five or more years to retirement, you should welcome each pullback in the market as a tremendous opportunity.

With this understanding, there are some small ways to take advantage of the recent market turmoil and use the recent drop in prices to your advantage:

Put excess cash to work; if you haven’t made your IRA contribution, now is a good time.
Rebalance your portfolio.
Swap losing positions to harvest tax losses; replace your high expense funds with tax-efficient, low cost ETFs. Use the downturn as an opportunity to clean up your portfolio.
Add Emerging Market equities, if you don’t have any. EM is down more than domestic equities and has lagged for several years.

Market timing may be an alluring mirage, but ultimately is a counterproductive distraction for investors. If you’re able to take advantage of the pullback, that’s fine, but if you’re already invested, don’t think that you have to “do something”. Most of the time, doing nothing is ultimately the best option!

Machiavelli and Happiness in an Age of Materialism

Posted On September 1, 2014 By Admin In Financial Planning /

Hence it is to be remarked that, in seizing a state, the usurper ought to examine closely into all those injuries which it is necessary for him to inflict, and to do them all at one stroke so as not to have to repeat them daily; and thus by not unsettling men he will be able to reassure them, and win them to himself by benefits. He who does otherwise, either from timidity or evil advice, is always compelled to keep the knife in his hand; neither can he rely on his subjects, nor can they attach themselves to him, owing to their continued and repeated wrongs. For injuries ought to be done all at one time, so that, being tasted less, they offend less; benefits ought to be given little by little, so that the flavour of them may last longer.

– Niccolo Machiavelli, The Prince (1505)

Machiavelli’s political treatise, The Prince, remains an interesting, at times brutish, study of human nature 500 years after being written. If you’ll grant me some liberty in interpretation, his advice to experience pain quickly and reward slowly applies nicely to today’s field of behavioral finance.

The Hedonic Treadmill is a psychological premise that people require constant effort to maintain satisfaction, or “happiness”, if you will. A related concept is Habituation, which is that we tend to have a baseline state of happiness, and that when events move us above or below that level, we gradually become used to the new situation and revert back to our previous levels of satisfaction. Both principles suggest that to increase and maintain happiness, we have to work at it continually.

Consumer spending is important to our economy, but at the household level, we’re spending more and more money to realize a middle class lifestyle. Economists look at things like the change in the price of a gallon of milk as inflation, but it might also be relevant to consider how living has changed for the typical family. In 1973, the average new house size was 1,660 square feet, compared to 2,679 square feet last year. Over the same time, the average household size has shrunk from 3.01 persons to 2.54. Today, we have many more bills – cell phone, internet, satellite TV – than existed 40 years ago. These are all great improvements over previous technology, but the cost of a middle class lifestyle has likely grown well in excess of the reported inflation rates in the CPI. But are we happier for the increased spending?

We experience a brief increase in happiness from buying new items, but habituation has two effects: (1) the enjoyment we get from a new item quickly wears off, and (2) once we do become accustomed to the “bigger and better” item, we are generally unwilling to replace it with a lower cost option. Once we have a smart phone, there’s no going back to a regular phone. After living in a 3,000 square foot house, a 2,000 square foot house feels too small. If you’ve owned a luxury car, you won’t want to drive a simpler car. Will a Kia get you to work as effectively as a Mercedes? Yes, of course, but that’s not the reason we buy an expensive car. We decide what we want and then we rationalize why we have to have it.

I chose the name Good Life Wealth Management, because I view money as a tool to help us enjoy life. Not in the materialistic sense of fancy cars or fine wine, but in the holistic pursuit of finding meaning and balance. The Good Life, then, is not achieved by the acquisition of items, but by enjoying a state of financial independence and using those resources to live fully. It’s my job to help investors find that freedom and I love my job. It’s the last thing I think about at night and the first thing I think about in the morning.

I share the following six principles to define what we stand for. This is how we can seek happiness and financial security in an age of materialism. If these make sense to you, then I think our financial planning approach and sense of purpose will resonate strongly with your goals.

Spend money on experiences rather than things. I went on a hot air balloon ride this summer. If I considered the cost for a one-hour flight, it was perhaps expensive. However, I have since spent many hours thinking about that wonderful experience and enjoying my photographs of that day. I’ll always have those memories.
As Machiavelli suggests, take pain quickly and rewards slowly. If you decide to make spending cuts to be able to save more, make the cuts deep and immediate. If you want to save an additional $1,000 a month, you’re not going to get there by giving up a daily coffee. And you’re setting yourself up for continual frustration because you will have to make that sacrifice every day going forward. By making many small changes, it will feel like a death by 1000 cuts. Instead, have the courage to make a big move like downsizing or finding a different job. Once you adjust to the new change, it will be fine and it is not going to impact your happiness in the long-run. (To see an extreme example of a human’s ability to adapt, two friends recently completed a Buy Nothing Year, with interesting reflections on their experience.) Take your rewards slowly to enjoy them. Feed your Hedonic Treadmill gradually.
Saving is not self-denial. Some people view saving and investing from a negative view – they only do it out of fear. Fear of falling behind, fear of not having enough, fear of dying broke. No one wants to experience any of those unpleasant things, but fear will only motivate you to save so much. And you’ll resent the saving because you’re doing it because you have to and not because you want to. Saving can be its own reward. Make it fun and a game to see how much you can save. If you want to be financially independent, take the steps that will get you there as soon as possible. Do it for yourself – the more you save, the faster you achieve your next goal. Be laser-focused, driven, and determined when you have a goal. Saving is a virtuous cycle when it becomes an ingrained habit.
Money doesn’t define us and our value is not a number. If I did lose everything, I know I could make it all back. And I’d make it back even faster because I wouldn’t make all the mistakes I did the first time around! That doesn’t mean it’s okay to be reckless with investing, only that money is not the most important thing in life. And once you have money-making knowledge and skills, you realize that wealth is abundantly available for those willing to save and invest.
Our concept of frugality was framed by our parents or grandparents who lived through the Great Depression in the 1930’s. They learned to be self-reliant and strong, but for some, those tough times created permanent fear and mistrust. (Can you feel fulfilled and happy if you bury cash in coffee cans in your back yard because you think banks will lose your money?) The new frugality is about simplicity, optimism, and making the decision to place financial independence ahead of consumerism. It’s a positive choice and not a negative reaction based on hoarding, fear of loss, or mistrust of the system. Used properly, frugality is having the maturity to make decisions today that will be smart 10 years from now. It’s a recognition that “more stuff” does not create lasting happiness.
Tis better to give than receive. Donate, volunteer, make a difference. Happiness comes from a sense of purpose and living to the best of your abilities. Daniel Kahneman found that higher income increased happiness, but only up to about $75,000. Above that level, individual differences prevailed. Money does not create happiness, but we do know what is the most common cause for unhappiness: loneliness. Connect with people. Use your money to visit friends, take someone to lunch, or travel and make new friends.

Is your money helping you move closer towards financial independence or is the rising tide of middle class materialism keeping those goals a distant dream? If you’re not sure where to begin, give me a call and let’s get to work on your financial plan.