Making Costly Mistakes

Recently during an introductory meeting with a prospective new client, the following questions came up:

      - Why do I need a financial advisor?

      - Can't I build my own portfolio and pay much less?

Those are really great questions and we are the first ones to admit, having reviewed many portfolios, that some investors are able to design good portfolios. In fact, we know that portfolio structure and low cost are the main contributors for wealth accumulation. 

So, is the question really about advisory fees or, rather, gaining a better understanding of the benefits of having a financial advisor onboard?

Shouldn't the question be: "What is the real value of an advisor?"

The answer is simple: Behavioral Finance.

It is a term we use to help clients understand that the future outcome of their financial well-being depends on how they make decisions with their money.

What exactly do we mean by that? Take a moment to read and honestly answer the following questions:

How do I know with certainty that my decision-making process is truly a rational one?

Is it possible that my brain is wired to create and use faulty shortcuts, influenced by past investment experience?

Would I benefit from understanding why the brain makes investment mistakes?

And last, what is the value of avoiding those costly mistakes in the future?

Below are just a few examples of the brain's systematic errors, best described with behavioral biases.

• Familiarity Bias: Investors have a bias toward stocks they know. Frequently, they favor their employer's company stock and take comfort owning large U.S. company stocks. In both cases, the results are poor diversification, higher volatility, and potentially lower returns. "Owning what you think you know" can be a costly mistake.

• Over-Confidence Bias: This systematic error of the brain is very pervasive in people thinking they are smarter than everyone else. Being very bright does not necessarily translate into superior stock selection. Trying to bet against the collective knowledge of millions of other smart investors can sometimes lead an individual down a path of gambling away their fortune. Over-confidence bias is a serious threat to prosperity.

• Hindsight Bias: We all know that past performance is no guarantee for future results, or as we like to say: "hindsight is not foresight." Knowing that interest rates are at historic lows or stock markets are reaching new highs doesn't tell us anything about future results. Using the past to predict the future is really not foresight; it is still hindsight. Investors who have stood on the sidelines for many years waiting for the next big market drop in order to get in at a discounted price have to admit that hindsight bias can be a costly mistake.

So, the answer to the question, “what is the real value of an advisor?” is simply this: We provide the tools to help clients look at their behavioral biases and gain an understanding of how they make important decisions with their money—and how they may be doing it irrationally. Realizing our brain's own shortcuts and the impact it can have on our financial future is important. Having a financial advisor to prevent you from making costly mistakes in the future is invaluable.

Summing it all up:

We described a few examples of the many shortcuts our brain uses and how we make important investment decisions based on irrational biases. As financial advisors, we might not always agree with you, but our first priority is your financial well-being.

Think of BMM as your financial physician. Doctors go through your prior medical history, trying to cure whatever ails you by providing medicine or treatment. We are in business of increasing not your health, but your wealth.

It is our responsibility to help clients not only recognize behavioral biases and faulty reasoning, but more importantly to prevent them from making costly mistakes in the future. That is the true value that we as financial advisors add to our clients.

Investment advisory services are offered through Berson Money Management, a registered investment adviser offering advisory services in the State of California and in other jurisdictions where exempted.  This communication is not to be directly or indirectly interpreted as a solicitation of investment advisory services to residents of another jurisdiction unless otherwise permitted.   The contents of this email and any accompanying documents are confidential and for the sole use of the entity to whom they are addressed.   They are not to be copied, quoted, excerpted or distributed without express written permission of the firm.  Any other use beyond its author's intent, distribution or copying of the contents of this e‐mail is strictly prohibited.  Nothing in this document is intended as legal, accounting, or tax advice, and is for informational purposes only.

Is the U.S. Stock Market Overvalued?

I always make the effort to be very straightforward about how I approach a person’s finances.  This way my client and I will have no concerns as to where we are along our journey.

So, when I read the many Wall Street articles on this question, I found many misconceptions about our stock market today.  I wanted to write this article to clear up some of them and hopefully give you my insights on how to protect your investments the way successful investors do.

It begins with a strategy that outlines where a person is today in their financial health as well as where they are going.  Some people are at the very beginning of their financial health and need to tweak their fastest pathway to cash, while others are looking for their investments to grow.

We hear people talk about success in investing but most don’t talk about failures.   However, both are present.  Most people love to talk about the bull (stock markets moving up) versus the bear (stock markets moving down).  Today’s bull market began in 2009.  And for the past 5 years, it has been in an upward tear.  In fact, in 2012, the stock market (S&P 500) rose over 16% and a year later, in 2013, it rose over 30%.

So it doesn't surprise me when people worry about the stock market being overvalued.  At some point, this bull market will reverse and turn into a bear market.  Today’s 5-year bull market preceded our 2008 bear market where the stock market (S&P 500) dropped 37%.

The math will explain why a double digit fall can be so devastating.  As an investor, if you have a $100,000 investment account and it drops 37% ($37,000), you feel that.  And it doesn't feel good.

Ever start a hike walking downhill before having to turn around an hour later and walk back up the hill?  Walking up the hill is much harder and not nearly as fun.  That is the reality.  And this is the fear—because you would need more than a 60% return just to bring you back to your starting point of $100,000.

So, is our stock market (S&P 500) overvalued today?  In my opinion, it is.  But that isn't the question an investor should be asking.

As an investor, it is important to have a clear investment strategy—one that recognizes where you are today, what your needs may be over the next year and in the future, and how to best get you there while allowing you to sleep soundly at night.

This strategy is important no matter what our stock market is doing.  That doesn't mean you can’t invest a portion of your investment to protect you from a 37% decline.  That doesn't mean you can’t invest in the stock market.  It simply means having several strategies in place.

You could include a strategy that will reduce the downside exposure in the U.S. stock market during a severe bear market.  And add a global asset allocation strategy in addition.  There are many options.

The idea that you can’t time the stock market is nonsense.  However, most are looking for perfection—and that isn't a strategy.  This is no different than trying to correctly time which is the right lane to be driving in during severe traffic congestion.  You should focus instead on how to reach your destination safely.

It doesn't matter if you are person who breaks at every red light or if you floor the gas pedal when the traffic
light goes from green to yellow.   Knowing the risk in all cases and having a strategy to get you home safely is what is important.  Stock markets fluctuate.  This is expected if you are an investor.  Having an investment strategy in place to handle these fluctuations should be a requirement for every sound investment plan.

But the question at hand is, “should I be heading for the exit?”  At this point, I can only talk from a blind position, meaning one without a strategy in place.  But as of today, no, I wouldn't recommend heading for the exit.  Even though I believe the market is severely overvalued, I also believe it can still move higher.  I believe we will have a good 2014 and possible even a good 2015 in the S&P 500.

My advice is to develop a sound strategy that matches your temperament as a long-term investor.  In my experience, finding the next greatest hit is harder than market timing and usually the hit doesn't last forever. 

If you need help putting a strategy into place, we would love to be of service to you. Please schedule an appointment with us.

Investment advisory services are offered through Berson Money Management, a registered investment adviser offering advisory services in the State of California and in other jurisdictions where exempted.  This communication is not to be directly or indirectly interpreted as a solicitation of investment advisory services to residents of another jurisdiction unless otherwise permitted.   The contents of this email and any accompanying documents are confidential and for the sole use of the entity to whom they are addressed.   They are not to be copied, quoted, excerpted or distributed without express written permission of the firm.  Any other use beyond its author's intent, distribution or copying of the contents of this e‐mail is strictly prohibited.  Nothing in this document is intended as legal, accounting, or tax advice, and is for informational purposes only.