The Double Edged Sword: Euphoria and Panic

Over the last two weeks, we’ve broken down the horrifying results revealed by the Dalbar Report and we’ve begun to delve into the reasons why they exist so you can potentially avoid them.

This week, I’d like to reveal a major contributor to these awful results, the ‘the double edged sword”, so we can begin to get to the root of the problem and help you confidently spend what you’ve taken your entire life to accumulate, without the constant fear that you’re going to run out!

Before we do that, however, let’s quickly refresh our memories of what the Dalbar Report revealed:

  • The S&P 500 Stock Market Index earned 2.12% (including dividends reinvested) in 2011
  • Over the same twelve month period, the return of the “average” investor who invested in the stock market (not an investment, but an investor, i.e. a person) was -5.73%.

However, as we discussed, anyone can have a bad year and this is too small of sample size, so Dalbar also presented their findings for the last 20 years ending on December 31, 2011:

  • The Average annual return of the S&P 500 Stock Market Index from 1992 – 2011 was 7.81% (including dividends reinvested)
  • However, the average annual return of the “average” equity investor (not an investment, but an investor, i.e. a person) over the same 20 year period was 3.49%

What these numbers tell us is that, while the S&P 500 Market Index delivered an average annual return over those 20 years of 7.81%, the average stock fund investor (a person, not an investment) only achieved 3.49%!

That means that the average equity investor’s return was 55% less than the broad market index each and every year!

Not exactly very encouraging news!

The Effect

There are many, many reasons why social security statistics continue to demonstrate that only 6% of Americans are financially independent at retirement age, and can continue their same standard of living throughout their retirement years.

This Dalbar report illustrates a huge one!

On the flip side, however, the wonderful news out of all of this for you is that it’s completely within your control to close this performance gap.

This ugly performance gap is not the result of bad investments or bad markets.

It’s the direct result of poor investor strategy and behavior (action or inaction), all of which you have the ability to control!

Enjoying the relaxing retirement that you’ve worked so hard for and deserve requires not only action on your part, but resisting the allure of the wrong actions taken by the overwhelming majority of retirees.

Side #1 of the Double Edged Sword: Euphoria

What exactly is Euphoria, and why is it a problem when investing?

Well, it’s the financial equivalent of “rapture of the deep”, a phenomenon which overtakes scuba divers when they dive down really deep.

Divers get completely blissed out and they lose any adult sense of danger.

The same thing occurs with investment Euphoria.

When you’re in The Euphoria Zone, there’s a complete lack of acknowledgement of the idea that loss is even a possibility.

The best way to identify this in anyone, including yourself, is when their identification of loss, or their definition of risk, is being “outperformed” by somebody else!

They completely lose sight of their objectives and their plans and, instead, are attracted to the bright, shiny object of someone hitting a temporary investment home run.

When all you’re worried about is somebody making more money than you are, you’re in The Euphoria Zone.

What they lose sight of completely is the fact that in order to achieve higher and higher rates of return, they must take on greater and greater amount of principle risk.

1997 to 1999: The “New” Economy

The classic example of this was from 1997 through 1999 when people bought internet stocks at price multiples of 75 to 1!

Even those who were earning good rates of return doing what they were already doing. But, that didn’t matter because others were earning more so they jumped into the pond without a second thought about the potential ramifications.

2005: Real Estate

Another example of this was real estate in 2005. There was no price that was too high to pay for a pre-developed condo in Boca Raton or Naples, Florida because they just knew it would double in price in 3 years!

In hindsight, we now know what the result of this is. Condos in those towns are now selling for 25 to 40 cents on the dollar. I have a friend who bought a condo in Naples for $429,000 that he can’t sell today for $129,000!

What essentially occurs in The Euphoria Zone is the complete loss of any sense of risk at all. None.

And, that’s one of the biggest mistakes that leads to irrational investing and the horrific results revealed in the Dalbar Report.

Side #2 of the Double Edged Sword: Panic

Interestingly, there’s another more common behavior which leads to the same horrific investment results, but it stems from the complete opposite end of the Double Edged Sword…and that’s PANIC!

Retirement Investor Panic can be measured the same way as Euphoria, except in the opposite direction.

When you’re in the Panic phase, there is a complete sense that there is no price at which you can intelligently sell because it will always be lower tomorrow…and then lower again the next day after that.

You’ve watched the news. You’ve read all the articles. They’re “all” saying it so it must be true: “This time is different! The market will never come back. And, if it does, it won’t come back in your lifetime!”

So, the only solution is to get out.

Sound familiar?

When you’ve reached this point, you’re in the Panic Phase and history has proven that it’s extremely destructive.

At each great market bottom over the last 65 years, including the one we experienced in March, 2009, and the mini-corrections we’ve experienced over the last two years in the middle of each year, the exact same headlines existed in newspapers:

“This Time Is Different”

Those four words may be the most destructive collection of words for any investor.

The reality is that it’s always different…..yet the same. The problem is that when we’re in the middle of the “fire”, it’s challenging to remain calm and rational and think long term.

In the short term, it always appears to be a completely unique period of time. And, the mass media does a great job of selling that.

However, if you study history, what you’ll find is that what contributed to most market bottoms was the same factor.

How to Think About This

What I want you to know is that I’m not suggesting that you should just blissfully invest and pay no attention to anything.

I’m also not suggesting that you don’t have a right to feel anxious at times.

What I am suggesting is twofold:

  1. First, this all pre-supposes that you’ve taken the time to carefully craft a Retirement Blueprint™ which takes into account every aspect of your financial life.

    That you’ve carefully projected out all of your fixed income sources into the future, i.e. pensions and social security.

    You’ve carefully calculated your spending priorities for both fixed and discretionary expenses into the future.

    You’ve forecasted out and determined the investment rate of return that you need to earn in order for your investments remain intact for the remainder of your life (adjusting for annual inflation).

    And, that you’ve properly allocated and diversified your investments among several investment styles and sizes that collectively have the realistic potential to deliver the investment rate of return you need to earn.

  2. Second, what I am suggesting in today’s Retirement Coach Strategy of the Week is that the difference between getting market returns and the returns earned by the overwhelming majority of retirees over the last twenty years, which were 55% less than market index returns, is NOT due to the market.

    If it was due to the market, everyone would earn what markets have produced which are extraordinary long term returns. But, the average retiree earned 55% less than the stock market index over the last 20 years.

    So, the question you have to ask yourself is WHY.

    And, the answer is it’s due to investor behavior. In other words, what retirees do as opposed to how markets perform, which is 100% in your control.

That’s the good news. Each of these is completely in our control. What a phenomenal opportunity we all have.

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

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