The Benefits & Dangers of Cash

When stocks and bonds experience negative performance, as they have this year, many investors become interested in cash. Indeed, some will repeat the mantra, “cash is king.” This has certainly been the case this year as nominal yields have been increasing to levels we haven’t seen in years. But, as with any financial decision, it is important to understand the benefits and dangers of any change in strategy before we act.

The Benefits of Cash

The greatest benefit of cash comes when we view and utilize it for short-term needs such as paying monthly expenses, buying a car, or funding an upcoming vacation. Whether the cash is set aside in our checking account or an emergency savings account, it’s not about the yield but the accessibility and dependability of the US dollar.

An allocation to cash for upcoming (or unexpected) expenses reduces the risk of having to sell stocks or bonds that are down in value to pay your bills. Cash is of greatest benefit when it is used to pay for upcoming expenses, saved in an emergency fund for unexpected expenses, and as part of an investment strategy with stocks, bonds, and other investment assets.

The Dangers of Cash

The greatest dangers of cash are when we utilize it as an investment (or parking spot) within a long-term investment portfolio. While cash offers a positive nominal yield, it almost always produces a negative real return (interest rate less inflation rate). Due to its negative real return, cash is not a sustainable long-term investment strategy.

Some investors are tempted to use cash as a “parking spot” when experiencing losses in their investments. While moving to cash will remove the immediate risk of short-term loss, and likely provide instant emotional relief, it introduces significantly more risk to future returns. Since cash is not a sustainable long-term investment strategy, the investor must guess when to get back in.

Let’s say the market goes up 15% from the bottom. Is it now “safe” to get back in? What about 20%, or 30%? What if the market goes up, the investor re-enters the market, and it goes down again? Does the investor move back to cash? And at what point would the investor realize the train has left the station (bull market) and the investor is not on board?

You get the point. Going to cash in an investment portfolio provides temporary emotional relief and stops the short-term bleeding, but introduces significantly more risk as the investor has become a speculator – trying to figure out when to get back in and how long to stay.

©2022 The Behavioral Finance Network

Your Guide to Year-End Financial Planning for 2022

As 2022 comes to a close, you’ll want to reassess your financial goals, examine any life changes that will affect your saving or spending, and learn about recent developments in the world of taxes and finance that might benefit you. So, before you head to your annual meeting with your financial advisor, read over these questions and use them as a helpful guide for your conversation.

  1. Can I Contribute More to Retirement Funds?
    While the state of the economy might make you hesitant about setting additional income aside, consider whether you’re financially able to maximize (or increase) contributions to your workplace retirement plan. At the very least, find out if you’re contributing the minimum to take full advantage of any employer match benefit. Increasing your contributions to a traditional IRA is another option, though you should be mindful that those with higher incomes may not qualify for a tax deduction.
  2. Do I Have FSA Dollars to Spend or Carry Over?
    Use what you can from your flexible spending account (FSA), and check your employer’s plan to see how much of any unused funds you can carry over to the next plan year. Although the rollover option applies to your employer’s plan year rather than the calendar year, this year-end assessment is a good reminder to make sure you’re on track. If permitted, the maximum FSA carryover amount is $570. If you have a dependent care FSA, you can save as much as $5,000 (family limit) or 2,500 (married filing separately) in 2022. Now is also a great time to discuss with your advisor maximum health savings account (HSA) contributions if you have a high-deductible health plan (HDHP). This can be a fairly complex topic in general, so it’s a great idea to tap into your advisor’s knowledge to learn more.
  3. Should I Consider Roth Conversions?
    If you have some room in your current tax bracket before reaching a higher federal income tax rate, you may want to consider doing a Roth Conversion. This would involve converting some of your pre-tax retirement savings, like in a traditional IRA, into a post-tax account, like a Roth IRA, so you’d never have to pay taxes on future earnings. Taxes would be paid up front on the conversion amount, and you’d enjoy tax-free growth in the future. If this interests you, discuss this strategy with your advisor, who can help determine if it’s an ideal time to do a conversion. He or she can also run projections to see if you would end up paying less in taxes overtime with this strategy.
  4. What Is Tax-Loss Harvesting?
    If some investments in your portfolio have suffered a loss, the end of the year is a common time to consider if it would make sense to “harvest losses” by selling them. Doing so can offset gains you have realized in your portfolio, as well as up to $3,000 of your earned income. Tax-loss harvesting can get complex, so this is a great topic about which to seek professional help. Be aware: Investments can only be rebought after a certain period, as selling a security for a loss and buying back within 30 days does not qualify.
  5. Do My Charitable Donations Qualify for a Tax Deduction?
    Charitable contributions donated directly to a qualified charity or to a donor-advised fund can help you get a federal tax deduction. Keep in mind, however, that this will often only be beneficial if you’re itemizing. It’s worthwhile to discuss with your tax professional if your charitable contributions, in addition to other deductions, will surpass your standard deduction.
  6. What Should My Strategy for Stock Options Be?
    If you have vested stock options included in your compensation package from your employer, now may be a good time to consider whether it would be more beneficial to sell them in January of 2023 as opposed to this year. Review your stock option statement and plan document with your tax professional and discuss which year may provide you the best opportunity from an income tax perspective.
  7. Do I Need to Think About RMDs?
    Some retirement accounts are subject to required minimum distributions (RMDs). This means once you are nearing approximately age 72, you may be required to start taking distributions from your retirement accounts, owing taxes on the way out. It’s not uncommon for people to forget to take RMDs. What’s more, recent legislation has made them a bit more complex, so RMDs for retirees and their beneficiaries are best planned with your advisor to be sure you’re following the rules.
  8. When Do I Need to Resume Repaying Student Loans, and Do I Qualify for Student Debt Relief?
    Student loan payments are set to restart at the commencement of 2023. Under the Biden administration’s one-time student loan debt relief plan, payments could be reduced to 5 percent of discretionary income for most undergraduate loans. More information on this plan will be announced in the coming days and weeks. To get the latest, consult this helpful fact sheet and sign up for updates on the U.S. Department of Education website.
  9. Should I Update My Estate Plans?
    It’s always a good idea to review estate plans as part of year-end financial planning. As life events happen, such as marriage or the birth of a child, your estate plan should be updated accordingly with your attorney. At the end of each year, discuss with your family how the life events you’ve experience over the last year might affect your estate planning. When you meet with your advisor, be sure to update and review beneficiary designations, trustee appointments, power of attorney provisions, and health care directives.

Take Advantage of Your Advisor’s Knowledge
Although this year-end financial planning checklist covers a lot of ground, it’s intended to serve just as a springboard for your planning conversations with your financial advisor. You’ll have a great starting point to talk through issues and deadlines that are most relevant to you, and you should be sure to add anything else you want to know to this list so you don’t forget to inquire. An annual planning meeting is a great time to ask any questions you need answered regarding your financial plans for the coming year.

These tools/hyperlinks are being provided as a courtesy and are for informational purposes only. We make no representation as to the completeness or accuracy of information provided at these websites.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
© 2022 Commonwealth Financial Network®

Everything is Transitory

Last year we were told that inflation was transitory. This year we learn that it is more persistent. And now investors have entered a bear market. Investors may be wondering how transitory or persistent this bear market may be. I wish we knew, but those kinds of things are only known after the fact. But recalling historical events can help us put today’s circumstances in correct perspective.

Big Historical Events Were Transitory

The Great Depression was transitory. So was the Civil War and every war mankind has engaged in. The Great Financial Crisis was transitory. Basically, anything that happens in life, no matter how long it lasts, is transitory so long as it has an end…eventually.

The definition of transitory is “of brief duration, not persistent.” But therein lies the ambiguity. How long is brief? How we define “brief” is subjective. It is based on the individual, the time horizon, and the activity undertaken. Is 30 minutes brief? Not if you are holding your breath. What if you are an investor? 30 minutes shouldn’t even register.

Transitory Events Can Cause Permanent Damage

We may amuse ourselves debating how transitory the bear market will be, but what really matters is that a bear market can cause great damage regardless of how transitory it is.

Millions have died in “transitory” wars. Many people suffer throughout their lives due some “transitory” abuse they experienced. Many investors had to significantly adjust their lifestyle from the transitory Great Financial Crisis because they sold during a transitory bear market and made their loss permanent. 

Historically, the markets have never not recovered from a significant downturn. The adage, “this too shall pass” is embraced by some of the most successful investors. Investors that construct an investment portfolio in line with their situation, needs, goals, and risk preference may be able to better withstand the transitory bear markets.

How Do You Define Transitory?

Most investors have a long-term strategy and plan. But we may still be influenced to make financial decisions based on transitory headlines and market movements. One of the best things you can do during a difficult time in the market is ask yourself: Is this situation transitory? You will find that crises, while they may last a while, tend to be transitory as businesses and consumers adapt and adjust. Such perspective will help you stay the course during this bear market, and even be able to take advantage of others’ shortsightedness.

©2022 The Behavioral Finance Network

Chasing Returns

A favorite (and costly) pastime of investors is to invest in assets that have recently done well. This happens in good times as investors seek better returns, and they happen in bad times as low-yielding investments such as cash are more attractive than money-losing stocks. In other words, investors chase returns.

By investing in what just did well, investors are systematically buying after they witness gains elsewhere and selling after their assets experience loss. Chasing returns can feel very good at the time but comes with a real financial cost. Dalbar, Inc. estimates that equity investors underperformed the S&P 500 by roughly 6% per year over the last 20 years1 due to the timing of buying and selling.

Why We Chase Returns

There are two primary reasons it feels right to buy after we witness gains and sell after experiencing losses:

  1. We are greatly influenced by what just happened. Whenever we try to project the future, our brains are significantly influenced by what just happened. Good outcomes today implies that things will be good going forward, and vice versa.
  • This is exacerbated by the narrative of the day. Our brains love a good story. We seek information to understand. When the market goes up, the narrative is often positive, leading us to feel good about the future. When the market goes down, the narrative is almost always negative, reinforcing a negative outlook.

Normal, But Not Beneficial

It is completely normal to invest in things we expect to go up and avoid assets we expect will go down. In fact, any rational person would do that as part of their investment strategy. But the problem is that markets move quickly and often surprisingly. Narratives are wonderful and can be quite accurate in hindsight. They can even increase our confidence in a certain viewpoint, but narratives offer no predictive ability in future outcomes.

This is why we advise you to remain disciplined to your plan and stay the course. We recognize this is not easy; temptations abound that are pleasing to our mind and feelings. But that is why you have us. Together, we can be aware of common investment pitfalls and ensure that all investment decisions are well-thought and in line with your stated objectives.

©2022 The Behavioral Finance Network

  1. JP Morgan Guide to the Markets. July 2022 edition. Slide 63.

If Money Doesn’t Buy Happiness, What Does?

For centuries mankind has been searching for happiness. Regardless of culture, social status, or beliefs it seems that we are all connected by our desire to be happy. What makes someone happy and how much happiness we feel may be subjective. But there are a few fundamental principles that tend to detract and add to an individual’s happiness.

In difficult or uncertain financial times, it can be helpful to take a step back and assess what makes us happy and what doesn’t. The good news is that everything that leads to lasting happiness is in our control.

 What Doesn’t Bring Happiness

Money, power, and prestige don’t bring happiness. Yes, they can provide certain opportunities that people may value, but they can also cause misery. The evidence is all around us. Money, power, and prestige can have insatiable appetites. Rather than feeling satisfied and content, we may feel urges to pursue more of it. This hedonic treadmill continues as we amass more, while never becoming satisfied.

The incessant pursuit of “more” often brings about negative feelings and behavior such as selfishness, backbiting, and egotism. Those are not the fruits of someone who is happy. But those are the qualities we see among many of the rich, famous, and powerful.

Three Drivers of Lasting Happiness

  1. Altruism/Selflessness. It is human nature to be selfish; us before them. Yet those that can rise above that instinct and sacrifice their own time, pleasure, and/or possessions for others find a huge return on investment. A return that is better than money.
  2. Positivity. There is so much negativity out there. In the daily news and even in comedy. Many seek laughs by putting other people down. It may provide a moment of thrill or happiness, but it is fleeting. We can find more enduring happiness by talking well about others and choosing to see the good in other people, even those we disagree with.
  3. Gratitude. People that demonstrate gratitude, especially for the little things, exude happiness. Gratitude helps us be less selfish, think highly of others, and keep our ego in check. Maybe we could say it’s the antithesis of unhappiness.

Our circumstances certainly play a role in how easy it is to feel happy, especially those moments when we experience a burst of intense happiness. But lasting happiness is more a function of how we think and act. While the world and markets may be uncertain and volatile, we can take comfort in knowing that much of our lasting happiness is within our control. 

©2022 The Behavioral Finance Network

Trusting Your Investment Decisions

Decision-Making Under Uncertainty

Investors face a very different environment today. While the future is always uncertain, today’s environment may be even more uncertain. We are living in a time of increasing inflation, increasing interest rates, and tighter fiscal and monetary policy. We aren’t used to this.

Making good decisions is always desirable. But when we face greater uncertainty, it is important that we trust whatever decision we make. A decision that looks to be “bad” in the short term can be quite profitable in the long run, and vice versa. So, how can we develop greater confidence in our decisions and trust them, even when they may not look so great in the short run?

Three Steps to Trusting Your Decisions

  1. Take Your Time. It is normal and natural to react to things based on emotions and intuition. The brain wants to solve things quickly, so we need to engage the reflective part of our brain by seeking additional information and not reacting hastily.
  2. Gather Information. We should spend a significant chunk of our time gathering information, including contradictory information. This helps us see things from various points of view rather than the loudest, or most repeated, viewpoints.
  3. Talk It Out. We would love to help you gather information, ask the right questions, and have a thoughtful discussion. Including an honest and objective 3rd party to help you think and talk through things is one of the best things we can do anytime we face an important choice.

We cannot control nor predict the markets, and that is OK. Because we can control how we think, analyze, and respond to the markets. We have found that how investors respond has a significant impact on their ultimate results. We are here to help you obtain the best results, despite challenging markets.

©2022 The Behavioral Finance Network

The Power of Remembering

Memorial Day is a time of remembering, reflecting, and honoring those who gave the ultimate sacrifice for the freedoms we enjoy today. The act of remembering often brings feelings of gratitude, love, and a desire to do good to others. It is positive and empowering.

While remembering can be very powerful with respect to certain holidays or important dates, such as anniversaries and birthdays, we don’t have to wait for a special day to unleash the power of remembering.

We can remember an individual, a circumstance, or any event in our life to get greater meaning and purpose from it. And, ironically enough, when we take time to remember and reflect on the past, we often develop better perspectives to tackle the future.

Remembering and Investing

As investors, we can also remember lessons we learned from the stock market and even through our own prior decisions. Every investor has made mistakes; the question is whether we remember those mistakes and have a plan to improve on it in the future.

For example, investors have a great ability to hold onto securities that have gone down in value. At least they can hold on to initial losses and/or for a certain period of time. But at some point, many investors get exhausted and impatient. They have a knack for selling near market bottoms. That is because it is darkest near the bottom and imagining any recovery may seem like nonsense. “This time is different” they say.

And perhaps one of the most important things to remember during a period of temporary losses, especially those that may be swift and severe, is how much you have made over the past five or ten years. Taking a longer view can help us put the current commotion in proper perspective.

And that is the power of remembering. Whether it is remembering where our freedoms came from, important people in our life, or how the markets work, remembering improves our perspective and, therefore, can improve our future decisions, in life or with respect to money.

©2022 The Behavioral Finance Network

Some Thoughts on Thinking

The ability to think clearly and draw correct conclusions is necessary in everyday life, especially when it comes to making important decisions. But thinking critically is not natural; it’s not the way our brains are hardwired. Instead, we are hardwired to follow the path of least resistance, which often results in hasty and suboptimal decisions. This is especially prevalent when uncertainty, anxiety, and emotions are high.

Assumptions: Necessary, But Unreliable

Because we seldom have full information, we must rely on assumptions to fill in the information gaps. These necessary, but often spurious assumptions can cause flaws in our thinking and judgement. If information seems plausible, especially if it is part of a good “story”, our brains will accept it as fact and move on.

As investors, we may assume that an “expert”, who has a lot of experience and is a frequent contributor on financial shows, knows what will happen and has our best interests at heart. We also unconsciously (and falsely) attribute one’s confidence with one’s ability to correctly predict the future. As much as we wish it were true, it’s not.

Even when we have full information, we still don’t know how others will respond – such as with the global shut down. Who would have thought the market would tread higher even as countries and economies shut down?

Critical Thinking is Critical for Investors

We are not born to be critical thinkers, just like we aren’t born to be great musicians. It takes effort, time, and practice. Critical thinking requires us to:

  1. Seek all available information – not just the information at your fingertips
  2. Play devil’s advocate – what if the opposite is true
  3. Challenge pre-existing opinions/conclusions

Cognitively, critical thinking is hard; it is draining. Which is why our thinking often defaults to the path of least resistance. And this is why you have us. We will do the heavy lifting. Thinking critically about the economy, markets, and your options are essential to making wise decisions. It may not be natural nor easy to think critically, but together we can ensure your financial decisions are thoughtful and in line with your plan.

©2022 The Behavioral Finance Network

The Holy Grail of Investing

Most investors would love to find the Holy Grail of investing – an investment that provides great returns with very little (or no) risk. Many investors consciously acknowledge that such an investment doesn’t exist. But we may still be attracted to that investment because of how badly we wish it would exist. And sometimes hope and desire, unconsciously, overrule logic and rationality.

A Recent Example

A few years ago, a mutual fund was created specifically for investors who were uncomfortable with volatility. The fund marketed itself as one that would “harness volatility” and “make volatility your asset.” It also claimed to be uncorrelated to traditional stocks and attempt to achieve both capital preservation and growth. Sounds like a real winner!

As you can imagine, money poured into this investment. It was marketed as the perfect investment for those concerned about volatility. It did well for a while, but just a single week of increased volatility blew the entire fund up. All the money was lost in less than one week! Ironically, volatility, the event the fund was going to “harness,” caused the fund to blow up.

Looking Forward

As investor concerns grow, we can expect that someone will create an investment product or strategy to “solve” the concern. Based on current headlines, we could see investments that claim to prosper during periods of inflation, stagflation, or “overextended” markets. No matter the concern of the day, we can reasonably assume the marketing will be very good – an emotional appeal to alleviate our concerns.

Our emotions and unconscious desires often inhibit skepticism and reasoning. Acting on emotions is the natural first response for many of us. It’s just the way we are hardwired. Thinking logically takes effort. That is why you have us. Together, we can ensure that your investment decisions are free from emotion, unconscious influences, and in line with your plan.

©2022 The Behavioral Finance Network. Used with permission.

Investing Amid Uncertainty

Investors express discomfort when things are uncertain. This is especially true when experiencing “heightened uncertainty,” such as with the current Eastern European conflict.

However, uncertainty is not just a circumstance of economic and investment markets, it is a fact of life. Our future, by definition, is uncertain. There are times when the future is less uncertain (the sun will rise tomorrow), but there are seldom, if ever, guarantees of future outcomes. In other words, life happens in probabilities. Learning to consider probabilities in our decision-making process will help us become more comfortable living with uncertainty.

The Probability Problem

The greatest challenge to thinking in probabilities is that it is just not natural. While gray matter fills our brains, they hate gray areas. They want to think in terms of certainty and will often convert a probabilistic scenario to either “will happen” or “will not happen.” An 85% chance of rain? The brain defaults to, “it’s certain to rain.”

When it comes to investing, we often hear terms such as “risk on” and “risk off” as if investing is just a switch. Investors similarly think in terms of “all in” or “all out.” This type of binary decision-making is natural, easy, and reinforced by the media. But it may lead to costly investment decisions.

Investing Probabilistically

Investing probabilistically is about adjusting your allocation, rather than making a significant move that amounts to a bet on which way the market will go. When the perception of the risk/reward balance is unfavorable, a small shift to safer assets is in order. And vice versa when the risk/reward balance is more favorable.

Because we cannot divine the future, the correctness of an investment decision should be based on strategy and probability, not the outcome. A good practice is to stop guessing what the market will do in the future. It cannot be known. Instead, consider making probabilistic adjustments proportionate with your risk tolerance. That will help you become more comfortable investing amid uncertainty.

©2022 The Behavioral Finance Network