Rule #1—Never lose money. Rule #2—Never forget rule #1.
A boy with a cocoon came to a farmer. "Look," he said, "the moth is trying to get out. I think I'll help him."
"Don't do it," the farmer said. "Let nature take its course."
An hour later the boy returned with a dead moth in his hand. "Why did he die?" he asked through tears.
"Because you gave him too much help," replied the farmer. "The moth gets his strength for life through the fight out of the cocoon. He needed to do it on his own."
Getting our financial wings is not going to be easy. We make mistakes, we struggle, we question ourselves. There are hard lessons to learn, but those that come the hard way seem to have the most sticking power. Anyone who tells you building wealth is easy hasn't lived outside a raging bull market.
If mastering the stock market and making our money grow were easy, we would all be multimillionaires. It is possible to become a successful investor if we can avoid some of the self-sabotaging mental traps that deceive today's investor. The saboteurs are an overconfident mind-set, a vulnerable emotional state, and a naïve psyche.
Following are five common mental errors that have infiltrated the modern investor landscape like a plague.
Bull markets provide fertile ground for feeding into the hubris of individual investors. If the stocks they pick skyrocket, they are geniuses; the stocks they pick tank, we blame the market. This logic always seems to provide a convenient excuse for investor foolishness. It's just this sort of hubris that led thousands of once-rational people to quit their job and become day traders at the end of the last century. lt was once said that failure is always a bastard while success has many fathers. Today's investors can raise their financial well-being by facing the fact that they are responsible for their successes and failures, or by realizing that they may not be responsible for either. Warren Buffett once said that everyone thinks he's a genius in a bull market because "a rising tide lifts all boats; it's not until the tide goes out that you find out who's swimming naked."
Most behavioral finance experts agree that today's investors are far too optimistic and smug about their ability to pick stocks. I had a personal epiphany during the market correction of April 2001. I had just mentioned to a colleague that my personal stock portfolio, which I was managing on my own, was up 120 percent for the year. That was before the correction took the air out of the Internet stocks. After the correction, my portfolio was up 20 percent for the year. The quick collapse of my portfolio value motivated me to take a closer look at what was really going on with my stock-picking ability. While 20 percent is still solid, I learned some hard, costly, but valuable lessons about the reasons that I had bought certain stocks. I learned that many others had (have) been making the same misjudgments as I. Here is what I found out about my ability to pick stocks when I took an honest look at how I arrived at my choices:
Remember all the hype, articles, and books about the new rules of the new economy? (Think back to the 1990s.) Ideas circulated that earnings numbers were basically irrelevant in the new marketplace and there were novel means for valuing a stock in this new world. I was in Silicon Valley giving a speech when I heard people from Internet companies bragging about their "burn rate," which is how fast their companies were going through investment capital. Companies that were bleeding money were watching their stock prices skyrocket. It was confusing to watch for anyone who believes in the fundamentals of valuing a company's stock.
Nobody will be heard bragging like that again because the other shoe (of earnings' reality) finally fell. They said all the measurements for success had changed from earnings and net profits to other nebulous quantifiers of success that only the person who speaks the language of HTML could understand. But in business, one number that will always be important is earnings; and sanity was finally restored with a flushing out of companies that couldn't produce earnings. Many investors, myself included, believed all the "new rules" tripe and hype and paid a heavy price for it. We were buying stocks because they were going up. Those who did got quickly reacquainted with the law of gravity. Don't ever forget this mathematical fact; a stock that falls 50 percent must now rise 100 percent to reattain its former value.
I live in Rochester, Minnesota, home of the Mayo Clinic and a large IBM facility. I have always marveled at the doctors who were investing in computer stocks they know nothing about and the IBM engineers who were investing in biotech companies they know nothing about. I made the mistake of trying to pick winners in sectors where you could fit the knowledge I had in the belly button of a gnat and still have room for a new boat and an SUV. Don't fool yourself. Each industry has idiosyncratic economic rules and distinctions for profitability. If you don't understand those economic rules and distinctions, you'd have a better chance picking stocks because they rhyme with orange.
At the time I didn't know the difference between an undervalued stock and a falling knife. I have cuts now to remind me of the difference. I created double jeopardy for myself by picking a falling stock in an industry I knew nothing about. All this stock-picking genius was, of course, aided by the wonderful research tools of the Internet at my disposal. We now have access to enough information to actually make us think we know what we are doing. Don't ever forget the difference between information and wisdom.
This was probably the most subtle deception of all—and one that many individuals will avoid investigating for fear that they, too, are in denial of their own speculative prowess. After the correction, I went through my portfolio to see how many of my stocks were up versus down. I had three that were up and nine that were down since I had bought them. Of the three that were up, two were up considerably and accounted for the 20 percent profit I was showing. I had gone fishing, landed two big fish, lost all my good lures in the process, and came to shore feeling like a good fisherman. My reality check showed that I was not a good fisherman; I was just lucky to be in a stocked pond.
Facing up to the truth about my own portfolio and abilities has tempered my desire to go out there shopping for a deal. Many people will sooner or later realize that they are not as smart as they think they are. There are professionals out there who spend 12 hours a day studying this stuff, and many of them feel lucky to get a 7 percent annual return on average. Humility will go a long way regarding your personal wealth. This may be an indicator of how the meek eventually inherit the earth.
"Past performance cannot guarantee future results." These words on the little caveat you read on the bottom of every prospectus are the truest words you'll read in the prospectus. Many people who chase hot stocks and funds have the same experience as a dog that chases parked cars. Just because a fund returned 68 percent last year promises nothing for the next year, but that doesn't stop thousands of people from moving their money from fund to fund on a year-to-year basis. This activity goes on so much that all companies now have penalties for transferring money before a reasonable period of time. Some people are now treating mutual funds like a day trader treats stocks.
Studies show that the funds that beat the market one year most often trail the industry average the next year. The exceptions to that rule have more to do with who is managing the fund and how consistent the philosophy of that fund is. Many funds switch their basic investing philosophy and even their managers without investors' being aware of the changes. These changes ultimately affect your personal wealth. It's important to decide on your own philosophy of investing and invest in funds that mirror that philosophy.
You can learn a lot by looking backward, but there is also a lot that can fool you by looking backward as well. If, in looking backward, you see a company that has for years increased its earnings and dividends, you are seeing good indicators—all other factors being equal. But if you simply look at how a stock price has appreciated and trust that it will continue to do so, you may be in for an unpleasant surprise. The fact that Cisco Systems went up 10,000 percent in nine years is no guarantee that it will go up even 10 percent in the next five years—or, for that matter, lose 50 percent in the next five years.
Many investors suffer from what behavioral finance experts call regret syndrome. The aversion we all have to emotions of regret is what causes us to hang out with losers in our portfolio. We have taken the axiom "You don't lose money until you sell" to irrational lengths. The question we need to ask ourselves is how much more are we going to lose by not putting that money in an investment with better prospects? Meir Statman, professor of finance at Santa Clara University, explains that it is a rare individual who can own up to a bad investment. "They avoid regret by holding on to a loser."
It's not easy to admit a mistake, especially a mistake with our money. It may make us feel stupid and ashamed and often angry with ourselves to let hard-earned wages slip away because of greed. Ari Kiev, author of Trading to Win: The Psychology of Mastering the Markets (John Wiley & Sons, 1998), states, "It's a denial of reality. We don't want to admit that we were wrong and take a loss. The hope is that the stock will turn around." If you buy a car that is a lemon, how long do you continue to pump money into it? Some stocks are lemons, and the first few signs of trouble are simply signs of more trouble to come. As my friend Gary DeMoss, a veteran of the financial services industry, put it, "After watching a few stocks I bought go down to zero, I decided I would let somebody else do the research on what stocks to buy." Gary has the bulk of his investments in mutual funds now. The best cure for a mistake is to admit it and learn from it not to wrap ourselves in the illusion of better days ahead. Take the loss, mark it in the ledger under "tuition paid," and move on with your investment life.
One of the fallacies of the information age is that you can profit easily from the plethora of information available on the Internet. "Information is easily accessible, so you can know what the pros know and make more money than ever before" is the theme of so many do-it-yourself financial services ads these days. One thing these ads neglect to tell you, however, is that once information becomes readily available and widely circulated, it no longer has any value. How can you claim an information edge when everyone else knows what you do? Even more ludicrous is buying a stock or fund touted in a financial magazine or newspaper. If there were any value to be bought, it was bought by the people who knew about it while the magazine was going to press. The smart money has already taken the profit while the masses are naively following the pundit's latest column or article.
James J. Cramer, cofounder of The Street.com and host of Mad Money, says the following about the unreliability of the information available out there, and talks about how the Internet has expedited the flow of false and misleading information:
Take these examples. A television hotshot speaks from the floor of some exchange somewhere telling me that National Gift Wrap and Box Co. is set to open a buck or two higher. Real news? Nah, that commentator got a call from someone long on National Gift who wants out before some bad news hits.
A message on a chat board talks about National Gift losing a key retail order to its competitor. Scoop? Hardly. That's just someone trying to smash down National Gift in order to cover a short profitably.
An analyst pushes National Gift, talking about massive undervaluation. Buying opportunity? Oh, please, that's just the more powerful investment banking arm pressuring the non-revenue-producing analyst into saying something positive about National Gift, a potential client. Too cynical? I don't think so. Every day, I hear and see things that I am supposed to hear and see, communicated to me by someone who wants me to take action... millions of others get fooled out of their pensions and their hard-earned savings every day of the week through manipulative stories masked as New Financial Journalism.
I cannot help but be amused by such an insightful observation coming from a gentleman who is as guilty of hype and ballyhoo and show biz disguised as financial insight as is Jim Cramer. He has proven to be a source of much heat but little light in his career as a "financial journalist." Those who are willing to stake their hard-earned life savings on the insights of this new breed of financial journalist had better be willing to follow them to the ends of the earth, because there is a good chance that this is exactly where they are headed.
A couple of years ago when my father died, he left my siblings and me a very nice inheritance. All of us, except one, invested the monies toward our own retirement. With any luck at all, we'll be there in five to ten years. My sister who didn't invest took her money and gave the bulk of it to her daughters. One daughter bought a house and the other bought furniture, clothes, a vehicle, and so on. Within a year the sister who gave her inheritance away was in dire straits because her husband became ill. Suddenly faced with the loss of income and potential for losing a spouse, she realized the foolishness of her generosity. Do you think her daughters were there to help her financially when she was struggling? Forget about it—they're too consumed with their own lives.
—Jane, 56
I almost feel a sense of guilt saying it, but in some ways I feel that we did too much for our kids. We had it hammered in our heads that we had to provide all the money for their college expenses, and we did for three kids. Two of those kids are now making more money than we will ever see and spending it as fast as they make it. We are getting to an age where we would like to slow down and do some things for ourselves, but we won't have enough money for many years. I'm happy we were able to help our children as much as we did, but it seems somewhat inequitable that they have it so good and we are so far from our own dream. I see now that there were other ways we could have helped them through school, and even if they had gotten loans, they could have paid them off with little stress.
—Jack, 58
This building block for financial well-being is built on the premise that people can borrow for college but they cannot borrow for retirement. This applies to those individuals who have marginal savings for their own emancipation and are breaking their own financial backs by giving their wealth to their children. According to financial writer Cort Smith, "There is a fundamental notion growing these days that parents don't owe their children a college education." This notion is gaining broader acceptance as more and more baby boomers realize that the life they have always dreamed of may be out of reach until it's too late if they put too much of their savings toward their children's education. In many cases, it's not a dream life that is being sacrificed. For some, it means working longer and harder than they want to at later ages and, consequently, having levels of stress at a time when they could have been enjoying free time and the fruits of their labors.
Who says the parent is obligated to provide a full ride for college for their kids? Is it pride? People don't realize how important it is to hold on to their retirement savings. I tell clients their priority is themselves. Kids have many years to work off tuition debt; parents don't.
—Nancy Bryant, financial adviser
Even if you can afford to hand your children their future on a silver platter, it may not be wise to do so. Each year, U.S. Trust, which manages the passed-on riches of wealthy people, conducts a survey of its clients to gauge their concerns. One survey (2007) found that respondents were concerned about the effects of wealth on their children and that their children were properly educated in the best ways to handle wealth. Eighty-seven percent agreed that it was important to encourage entrepreneurial values in their children, and 80 percent agreed that it was important that their children understand that wealth is a social responsibility. More than half (53 percent) were concerned about the negative impact of wealth on their children, while 43 percent felt they owed it to their children to leave a sizeable trust. Almost all high-net-worth parents (96 percent) felt it was important to teach children to manage wealth. Sixty-one percent reported that their children are actively involved in managing their wealth. There are certainly moral and behavioral pitfalls waiting for those who get too much too easily, but many wealthy parents have found that having money needn't interfere with raising responsible children.
In a recent Forbes article entitled "Who's Spoiled?" author Brigid McMenamin noted that many children with wealthy parents end up being fiscally responsible and quite industrious if they were raised with proper values and a hands-on parental approach. Children whose parents left the bulk of parenting chores to hired help were far less successful. An example of proper values and motivation is Matthew Zell, son of Chicago billionaire Sam Zell. The younger Zell says, "It was always expected of me that I would work. My father wanted me to give my best effort." Matthew Zell, after attending the University of Illinois, went to work at a computer service firm. After a while he decided to start his own company and used $5,000 he had saved on his own as seed capital.
Successful parents agree that you need to teach your kids self-sufficiency, even though the teaching methods are not always met with glee. Edwin Locke, author of The Prime Movers: Traits of the Great Wealth Creators (AMACOM, 2000), comments that regardless of how rich you are, your kids need to know that they can earn their own keep. "If you subordinate that to other things, then you don't love your child." Strong words to the wise echo back to the old saying about teaching someone to fish rather than giving the person a fish. All children, no matter how wealthy their parents, need to learn financial independence.
Tips from wealthy parents, whose children are responsible, hardworking citizens, include what I call the "Ten Commandments of Leaving a Financial Legacy."
Let them experience reality, which means not bailing them out when they screw up.
Show them what you value. Demonstrate with your life what matters most. Point out your heroes and mentors.
Encourage them to think. Ask their opinions and nurture their independent thinking skills.
Express delight when they do something well. This helps to build a sense that they can do things.
Give them opportunities to earn money. If they don't earn it, it doesn't have any value.
Let them enjoy the fruits of their labor. If you don't, it will dampen their initiative.
Let your children handle money. This is how they learn budgeting and restraint.
Make your children pay for the big things they want, such as college, cars, travel, and the like.
Once they finish school, let them support themselves.
Tell them not to expect an inheritance until they are old and gray. Why sow the seeds of lethargy?
As you may remember from earlier in the book, in my own home we came up with a good compromise regarding the costs of my kids' college educations. Here are the results of that compromise: My oldest son responded by deciding to attend a less expensive junior college before transferring to the four-year school that has the major he wants. He has since graduated, married, and is living in Alaska. My second son has started school and works diligently to pay his share of his tuition.
Here is the compromise we came up with: We told our children that we would match whatever amount of money that they saved for college. If they save $1, they receive $1. If they save $5,000 each year, they will receive $5,000 each year from us. We are leaving it up to their own initiative and work ethic. Another financial technique we used with my older son as he grew up was paying for half of his car insurance if he made the B honor roll in school. Otherwise, he would have to pay all the insurance himself. (He spent only one miserable semester off the honor roll during high school.) Even though he was just 13 at the time, my second son had already saved over $1,000 toward his college fund, which he invested in the stock market. He accumulated that money through odd jobs and financial gifts.
What good are you to your family and the world if you are miserable? This is not encouragement for selfishness but rather for common sense and self-preservation. Why would anyone want to potentially surrender the best years of their life and make life too easy for their children in the same process? The children need to learn the same lessons you learned and in the same fashion you learned them. In the end, it will be your children's character, not their credentials, that will give you the greatest pleasure.
Women especially need to spend more time thinking about their financial well-being in later years. According to a report by Prudential, although women planning for retirement have many of the same concerns as men, women face certain issues that may make it more difficult for them to save for retirement:
Women, on average, earn only 76 percent of what men earn (U.S. Department of Labor).
Women live, on average, seven years longer than men (Census Bureau).
Elderly women are three times as likely to be widowed as men (Census Bureau).
The national median concerns are staying at home to raise a family, divorce, dependence on spouse's income, and so on.
According to the 401khelpcenter.com, women lag behind on several other financial issues:
Women report contributing a median of 6 percent of their pay to their company-sponsored retirement account, compared to 7 percent for men.
Women report spending just 5 hours per year monitoring and managing their retirement accounts, compared to 10 hours for men. (Some studies view this behavior as a positive—less trading.)
Women report lower current retirement savings ($71,800 for female workers versus $122,700 for male workers). (Some might say men aren't being truthful or that they might be boasting or be ashamed to admit what they don't know.)
Women report not knowing as much as they should about retirement investing (80 percent for female workers versus 67 percent for male workers).
Despite having increasingly longer life expectancies, women estimate that they will need to save an average of just $639,000 to meet their retirement goals—one-third lower than men, who estimated they would need an average of $941,000. Despite having increasingly longer life expectancies, women estimate that they will need about a third less money than men estimate that they will need. Maybe women feel they could subsist on less or simply fail to comprehend the role of inflation in a long life.
"Women statistically live longer than men, are more likely to take time off from their careers or work part-time, and often earn less," said Catherine Collinson, retirement and market trends expert for the Transamerica Center for Retirement Studies. "These circumstances create added challenges for women when it comes to saving, planning for retirement, and budgeting for postretirement expenses."
Another way we need to think about ourselves is to occasionally take time out from our saving and retirement savings obsession to do something fun and frivolous for ourselves. Karen Ramsay, author of Everything You Know about Money Is Wrong (Regan Books, 1999), sometimes encourages clients who are having no fun that it is okay to take time out from their retirement contributions for a short period to have some fun while they're young enough to enjoy it. Ramsay asked one couple what their dreams were, and they defeatedly announced, "To go back to Europe for a vacation, but that will never happen." Ramsay's advice startled them. She told them to not maximize their contribution to their 401(k) and IRA for one year and go on that vacation to help reinvigorate their life. They did it, had the time of their lives, and never regretted it. There is more to life than saving for the future. Don't forget to reward yourself; it helps to fuel your initiative for the future.
Any good thing taken beyond the bounds of balance is no longer a good thing. Life is full of illustrations, as seen in the following, about stepping over the invisible lines of imbalance:
Physical rest becomes laziness.
Quietness becomes noncommunication.
The enjoyment of life becomes intemperance.
Physical pleasure becomes licentiousness.
Enjoyment of food becomes gluttony.
Self-care becomes selfishness.
Self-respect becomes conceit.
Cautiousness becomes anxiety.
Being positive becomes insensitive.
Loving kindness becomes overprotection.
Judgment becomes criticism.
Conscientiousness becomes perfectionism.
Interest in possessions of others becomes covetousness.
Ability to profit becomes avarice and greed.
Generosity becomes wastefulness.
There is an invisible line that we come to and can cross in all areas of life that marks the difference between balance and imbalance, discipline and mastery, chaos and control. We must constantly address and regulate all these compartments to keep areas of our life from spinning out of control. Once we identify where the lines are that we should not cross and develop emotional and logical thought patterns that keep us from crossing those lines, we have achieved what is commonly called maturity.
Money maturity comes by becoming aware of where we are—both intellectually and emotionally—with money issues. It comes by honestly examining our money behaviors and getting assistance where we are weak. It comes by acknowledging the places where money controls us instead of our controlling the money. Money maturity is a difficult issue for many. I have met hundreds of people who will not go to a financial professional for fear of what that person will see in their spending and saving habits. They are afraid of being embarrassed and feeling ashamed at their level of progress. They are afraid of feeling stupid. This fear exacerbates the problem and impedes the solution, which will begin with a humble acknowledgment that they don't know everything they need to know and that they have made mistakes. Anyone who has ever had money has made mistakes about it; it is an inherent fact of the human condition.
Money maturity is achieved when we are willing to go below the surface of our money behavior to ask ourselves why we feel the way we do about money. Our behavior is rooted in beliefs and values we learned. These beliefs and values have helped to form a personal identity with money, as seen in the following diverse comments.
"I'm a saver."
"I'm a spender."
"I'll never have enough money."
"I can't get enough money."
"Riches will ruin you."
"I'll never get ahead."
"There will always be money."
"I'd better enjoy it now because I may not be here tomorrow."
Our attitudes and beliefs about money have their genesis in messages we have received during our lifetime. The beliefs we have settled on are also premised on observations of our family and others' financial behaviors. Look back at your family life to see what values you have picked up.
In your home, was there an atmosphere of scarcity, plenty, or moderation?
How did your parents and their parents handle money?
Was money a source of conflict within your home?
Was money a taboo topic or dealt with in family discussions?
Did your parents try to teach you specific lessons regarding money management? What were those lessons?
As we grew up, we observed people other than family members and began to form habits and patterns of our own. Our financial behavior is rooted in our beliefs regarding money and life. Those who spend constantly believe that there will always be money available and also believe that they should live for the moment. Those who never spend and hoard their money believe that the earning spout can dry up at any time and that you must sacrifice the present to have hope for the future. These driving and controlling beliefs are based on observations people have made in their lifetime. Look back at the formation of your own beliefs.
Did you work when you were young?
How old were you when you had to take financial responsibility for yourself?
What was your first experience with debt? How did you handle that situation?
What was the financial status of your closest friends growing up?
How did you feel about people who had a lot of money?
When did you start saving money? Why did you start saving?
Have you ever felt rejection or inferiority because of your financial status?
Has money been a comfortable or stressful topic in your intimate relationships?
Have you used money as a means to control others or have you had others try to control you with money?
How does money contribute to your happiness?
How does money cause you tension and stress?
When you take a more introspective look at your own patterns and behaviors regarding money, you will see certain attitudes and beliefs surfacing. Some of these attitudes and beliefs are in balance and some are not. You may have to face the fact that your behavior or attitude is causing stress in other people's lives. You may discover that you have a hard time talking about money matters and need to ask yourself why. Money is a deeply personal issue. Our attitudes and behaviors regarding money are windows to our soul. I know that many people fail to get help for financial matters because they don't wish to open up this window.
Developing personal wealth or money maturity hinges on your ability to examine why you do as you do and then get the assistance you need to develop the habits of prosperity. When we become cognitively aware of our own level of maturity on the financial learning curve, we are well positioned for growth, both financially and as human beings. The values and beliefs that affect our financial well-being include understanding our risk tolerance, our patterns of saving and spending, and the beliefs that undergird our money habits. We need to assess where we are on the financial planning learning curve and decide how we will improve both our understanding and habits. Raising your financial well-being is, on one hand, a learning issue and, on the other hand, a self-examination issue. To increase your financial well-being requires honesty and a degree of humility. We need to be honest about what we don't know and start asking for answers from someone who can explain. We need to be honest about our levels of stress, tension, and insecurity regarding money and savings, and ask ourselves how we can improve our emotional approach to money matters. The end result of intellectual pursuit and applied emotional intelligence is greater financial well-being. The New Retirementality recognizes that once your awareness is raised, it is just a matter of time before your personal portfolio follows.