Author Carl Richards says investors need to look beyond the current economic dilemmas and understand what they can and cannot control in their portfolios.
Christine Benz: Hi, I'm Christine Benz from Morningstar. I'm here at the Morningstar Investment Conference, and I'm joined today by Carl Richards. He is the director of investor education at BAM Advisor Services, and he is also the author of a terrific new book called The Behavior Gap. Carl, thank you so much for being here.
Carl Richards: Thanks for having me.
Benz: Carl, one thing I want to talk about today, a lot of your work centers around how investors undermine their financial well-being by acting on emotion and making poor choices in opportune times. It seems like with the current environment with all the volatility we've had, concerns about Europe, slowing growth, and the fact that things aren't so good here in the U.S. either, I think investors have a tendency in environments like this to make decisions that could hurt their financial well-being. Let's talk about what some of those missteps might be in an environment like the current one.
Richards: It's sort of a new apocalypse du jour. We have another one. So I think there is this tendency--one of the big mistakes we make is taking the recent past and projecting it into the future. We do that in good times, and we do it in bad times. Right now it sort of shows up as "This European debt crisis will never go away."
Benz: It sure feels like it, right. It's been going on for a year at least.
Richards: It does feel like it's been going on long time, in fact, maybe it has been going on a long time. But the tendency is now to think, it's going to go on forever. And the other problem we have or other mistake we make is that we start calling these things problems. But most of the problems, financial problems or investment problems that we think we have, are really just some idea of some event that may or may not happen. We don't know exactly how this is all going to turn out.
So to make huge changes based on some projection of how something may turn out is clearly a mistake. I'm getting asked a lot about Europe right now, and I think it's sort of the wrong question. I think the better question is to figure out what are those things in my financial plan or investment plan that I can control, and why don't I focus on those.
Benz: So the solution isn't to look through your portfolio and purge everything that's Europe-related, it's to kind of take a step back and say, what are the things that are within my sphere of control because what's going on in Europe clearly isn't?
Richards: It's a really good question. It's just a tricky issue. Sure it's in your sphere of control to get rid of everything that's Europe-related. The dilemma of course is just about the time we decide to do those sorts of things, we are notoriously bad at timing, timing big catastrophes or timing big runs. We are notorious. We almost always make those decisions at the wrong time. So I think it makes more sense to step back and rely sort of on the weighty evidence of history.
At any time we start talking about historical evidence, but that doesn't apply anymore. But we have a choice. We can either use the data when we have tons of it and make decisions based on the data from history, the weighty evidence of history, or we can make some projection based on what we think is going to happen. And I tend to decide on the idea of using the weighty evidence of history. So we can look and say, look it makes sense to be globally diversified, right? It always has made sense. So why not continue to do what's always made sense?
Benz: What are the other things in addition to sort of minding that overall global portfolio? What are the other things that investors should stay plugged into because they are factors that they exert some control over?
Richards: Well I think the biggest gap, I think historically it's always been this way, is treating investments, our investment decisions, in isolation instead of tying them to an actual plan for our lives. Asking these big questions of why am I investing. And it sounds sort of like this crazy idea, but it's pretty simple. Where are you today? Where do you want to go? What are your goals? If you haven't done that, then you get sort of out on these limbs of all these investment discussions, and you get really worried and nervous. But if you've linked everything to a plan that says something like, and I'm making this up, "I should have 50% of my money in bonds and 50% of my money in stocks," that decision shouldn't be made based on how I feel about the market. That decision should be made based on my goals.
So, that's the big thing we have total control over, our allocation of clearly the big lever among stocks, bonds, and cash. And so, if we feel like we're learning new information about how much risk we feel like we want to take, well, then we should make adjustments with those levers. We should probably wait and do it slowly, but we should make adjustments with those levers. Does that make sense?
Benz: It does. So in addition to asset allocation, spending and savings rate would obviously be an even bigger lever that investors have. What are the other things that fall under that heading of factors that they control?
Richards: So asset allocation [is one thing]. Spending and savings. How much are you saving when these goals are going to happen. It's sort of like this retirement date, if you will, how you view retirement.
Benz: Which is fluid for people. A lot of people are working part time or longer than they thought they might.
Richards: Whether by choice or by design, we are seeing this definition of retirement changing a lot. I know lot of people that could chose to be done, who--because we're living longer and retiring earlier--are wanting to move into a second career or maybe scale back or something like that. So when you retire, I was talking about this once and somebody pointed out, "Well, there is another lever." I said, "What is it?" He said it's when you die; you could die earlier. That was hopefully tongue in cheek.
Benz: That's not under the category of what you control.
Richards: But I think the other things we control is expenses inside our investment options. We have control over that. We have control over the decisions we make. We don't have control over the tax ramifications, but we can think about our investments in terms of the after-tax rate of return, tax-loss harvesting. [Those are some of the] intelligent things that you can do there.
Benz: Carl, thank you so much for sharing your insights. We very much appreciate you being here.
Richards: Thanks for having me.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.