Last spring I was speaking with a prospective client who was well behind on his financial goals. He was his early 50s and recognized he wasn’t going to have enough money to retire with the lifestyle he wants. When we talked about the reason for the shortfall, he was confident he knew what it was: “I need higher returns.”
Generally when I do a review for a prospective client, my major concern is the investment portfolio. But in this case, it was totally a planning issue. Against my advice, he ended up selling his balanced portfolio and moved everything into a small number of Canadian stocks he felt would give him the returns he needed. I could have given him my recent white paper, The Risks of Concentrated Stock Portfolios, but I doubt that would have changed his decision.
The issue here was not his particularly bad timing: the US and international equities he sold have gone on to outperform what he bought by a wide margin, but six months is not a meaningful period. Nor was it the behavioural bias of chasing past performance, although this is a textbook example of Skating to Where The Puck Has Been. The deeper problem was this investor had completely ignored the real reason his retirement savings are not where they should be: he had not saved any money in several years, and had even withdrawn some of his savings to pay for his current lifestyle.
This investor is in his peak earning years, and he should be ramping up his savings for retirement. And not only is he spending his nest egg rather than trying to grow it, he is completely oblivious to the effect this is having on his financial future. For him, the solution is to try a different investment strategy.
Saving Money: Something You Can Control
Imagine you’re taking a long road trip and you’re concerned you might not reach your destination on time. You could increase your chances by ensuring your car is well maintained, by leaving early, and by carefully following your planned route. Or you could do none of those things and simply blame the weather if you arrive late. That sounds foolish, but it’s similar to the way many people treat their retirement planning.
“There are only six factors that determine the long-term value of your investment portfolio,” Alexander Green writes in The Gone Fishin’ Portfolio: how much you save, how long your investments compound, your asset allocation, your investment returns, your expenses, and your taxes. Of those six factors, only one is beyond your control: your investment returns. Yet this is the one so many people focus on.
I’m not sure why people believe their returns are the single most important ingredient. Maybe it has to do with what behavioral economists call the self-attribution bias, which is the tendency to take credit for our successes and blame external factors when we fail. If you’re staring at a large gap between your current portfolio and your investment goal, it’s hard to acknowledge the problem might be that you haven’t saved any money, or have spent too much money in retirement. It’s easier on the ego to blame the markets (or your advisor!).
Investment returns are important, of course, but they’re unpredictable. So it makes more sense to focus on the crucial factors we can control. Whether you make lump-sum savings or add a little bit every month, your savings rate is likely to have the biggest effect on your portfolio size when you retire. My role is to help clients with the other factors: selecting an appropriate asset mix and keeping expenses and taxes to a minimum. Everything else is just a distraction from what’s really important.