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Retirement Planning: Investment Lessons Learned January 19, 2009

Posted by retirementwithaplan in retirement.

Retirement Planning and Investment Lessons Learned

“I was unable to find flaws in my ‘proof’ for quite a while, even though the error is very obvious. It was a psychological problem, a blindness, an excitement, an inhibition of reasoning by an underlying fear of being wrong. Techniques leading to the abandonment of such inhibitions should be cultivated by every honest mathematician.” How many of us have said something like this, which was what John R. Stallings Jr., recently deceased at 74. Professor Stallings tackled Poincaré Conjecture and in the process, found a proof for part of one of the longest-standing problems in mathematics when we examine our own feeling on investing?

(The problem, for those of you that are interests suggests that any shape without holes can be reshaped, or as Poincaré said “deformed” into a sphere. Professor Stallings did it with seven dimensions. The problem was solved by Grigori Perelman in three.)

The reason I bring this quote to you is the question of confidence that he forced to ask himself in his mathematical pursuit of the answer. Do we as investors ask ourselves the same questions? Do we admit to the possibility of a psychological problem as Stallings did? Do we look blindly seeing what we want to see? Do we revel in the excitement, the thrill? Or do we suffer from unwillingness to admit error and the “inhibition of reasoning by an underlying fear of being wrong”? Do we?

011909wrg01More than likely the answer to those questions is yes. Professor Stallings, despite his gift, his achievements and the confidence that his mind could solve one of the most difficult mathematical challenges ever posed, was human. Just like us. He understood his biggest mistake was not in the calculation, but in the lack of humility surrounding the error he made. He never considered that he might not be correct.

If I were to ask these questions of you just twelve months ago, no doubt you would have stood firmly on your confidence. Your portfolio was a glowing example of your savvy. You would not have considered for one moment, the possibility that you might have turned off your ability to reason objectively, see clearly, be excited or admit that your investment choices could be second guessed.

Did the last six months, a period of angst and grief and second-guessing, of blame and confidence shattering losses, change you? Are you still the same? What lessons have you learned?

The Dream of If
Have you seen the prognosticators and fortunetellers for what they really are? How much did they matter before and will they matter again, offering insights that simply reaffirmed our choices? What we failed to do was parse information without becoming caught up in the dream of “if”. We do not like to admit we are wrong and in more cases than one, we are haunted by the possibility of “if”. If I had invested… If I had sold… If only I had known…

The folks who forecast the markets and predict the future are doing just that. They base what they know, much of which can be taken at face value, for the sole purpose of making their employers happy. Failing to understand that, we only see an opportunity where there might only be a business transaction, a work-a-day suggestion that so-and-so’s clients need to buy this and sell that. From that we often make a decision.

if011909_dblNo matter how many times you have been told to be diverse in your investments, you are not. Once again, we ask ourselves and are haunted by “if”. We watch portions of our portfolio grow exponentially over our other investment decisions and do nothing. We become excited, confident and blind to opinion that might suggest we should be otherwise. Or worse, we channel even more money into the particular asset in the hopes of reaping even more benefit from our wise and savvy choice.

The most sage investors refer to this strategy as keeping the powder dry (a reference used often by John Bogle who is old enough to have been around when that was an important part of firing a gun). Warren Buffet would suggest swimwear in his famous quote suggesting we will all know who is swimming naked when the tide goes out. All well and good advice: but only as good as your application of it.

From the Aftermath
Suppose that now, in the aftermath, you decided that these are admirable traits: diversification, conservative investing, and only the most cautious forays in alternative (what we now know as illiquid) assets and investments strategies. If we all adopt this type of investment style, won’t the recession last longer? Will all of those lost jobs return, the economy recover and losses turn into profits if we like the new tightness of our portfolios?

Will we forced to wax poetic about the days when you could make real money in the markets, not just grow it, nurture it and patiently wait for the fruits of one’s investment labor? Will we begin to think long-term?

Not to worry. It won’t happen. Hedge funds, real estate, venture capital, private-equity funds and natural resources all played a role in the demise of the markets we often think of as just stocks and they will be part of the recovery. The interwoven nature of what investing has become can allow us to become diversified at the same time it can corner us with too much of one holding and not enough allocation protection from another.

Some of the best money around has fallen into the trap of infallibility. Pensions and universities suffered enormous losses that none of them could have seen coming when they made plans for 2008. Now in 2009, they are feeling the pain and possibly thinking of swearing off the riskier of these investments in favor of the mediocre, the safe, the vanilla.

The Boundaries of Risk
Each downturn or bear market has its own personality, its reason for being. Yet all bull markets are identical. They all run on investor dopamine, strangling out good sense over caution. Mutual fund managers, the very people we looked for to guide those investments in many cases, at least those that live and breath like the shareholders they represent, are subject to the same reactions as you. They often embrace the upside of euphoria and on the downside, just like us, they panic.

Rational behavior is difficult to define. A recent column by New York columnist David Brooks suggests that “Markets tend toward efficiency. People respond in pretty straightforward ways to incentives. The invisible hand forms a spontaneous, dynamic order. Economic behavior can be accurately predicted through elegant models.” Only, as he points out, not this time. And possibly not ever again.

Of all of the advice that anyone could give you, one piece holds more strength than any. How you structure your portfolio is your business. If you never want to admit you are wrong, never want to second-guess your logic no matter how irrational, never want to rebalance or reallocate, that’s okay.

What you should do is set boundaries. If you can set the sell point both high and low, you need never have to worry, question your motives or forecast the “if”.



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