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In This Issue: Following the Herd? Well Don't A Visual Aid for Your Lookback Year
Following the Herd? Well Don't To get the New Year off to a rousing start, here’s some investment wisdom from Warren Buffett, Bill Gates, and Raven, a five-year-old chimpanzee. You’re probably familiar with Buffett and Gates. I’ll make a formal introduction to Raven momentarily. In a recent New Yorker profile of the Microsoft billionaire, Buffett described how exceptional individuals like Gates process information differently than most people: “They’re
wired in such a way that when they see business questions or
problems or activities they tend to get the picture very quickly.
They don’t get tangled up in prejudices or biases they
may have. They just tend to get the right answers. It’s
sort of like ‘Why was Ted Williams a great hitter?’
It’s about seventy-five percent DNA.” Smart
Stuff That leads us to Raven, the chimp, who built a portfolio of 10 Internet stocks by throwing 10 darts at a list of 133 pre-selected Internet companies. As of December 23, Raven’s selections had increased in value by 347.11% (you can check Raven’s performance at www.monkeydex.com). Raven is in strong contention for the title “Top Internet Stock-Picker of 1999.” What do the lessons of Buffett, Gates and Raven hold for the typical retirement investor? For starters, this is a time to pretend we’re Gates—it’s crucial that you understand your herding instinct and overcome it. According to the excellent book “Why Smart People Make Big Money Mistakes,” by Gary Belsky and Thomas Gilovich, the warning signs of a herding syndrome are:
If you are invested in a 401(k), the odds are very good that you suffer from herding syndrome. Surveys show that when 401(k) participants are asked, “What was the most important source of information influencing your choice of investment mix?” the most popular answer (80 percent) is, “I asked my friends what they did.” What
to Follow There’s no reason to be led around by the herding instinct. If you are serious about building personal wealth, you are far better off just rebalancing your accounts once a year, and then allowing your basic asset allocation mix, like a sensible pair of shoes, to do its work. Rather than fretting over investment changes or chasing last quarter’s “superstar” fund manager, you should try to reduce personal expenses, pay off your credit cards and save more money. If that’s where you focus your energy and resources, you’ll wind up with a more comfortable and secure retirement.
A Visual Aid for Your Lookback Year The year’s end is an opportune time to review retirement investments and consider changes in strategies. As you gear up for this task, I’d like to tell you about my friend, the options trader. During this past summer, my friend sold his trading company to a major investment bank for approximately $500 million. He owned 90% of the company, so investing the money is now his responsibility. How is this intelligent investor, with a background in hedges, straddles, and other exotic instruments, investing? In his view, a total market index fund offers the least risk of any single approach to the market. He is working with the purchaser of his company to construct the index fund he has in mind. He’s making a shift in his investment strategy and the way he thinks about his money. We may not have $500 million, but whatever we do have is worth just as much to us. That’s why it is important to conduct a serious year-end review of your retirement portfolio, and to take a reality check of the investments already in place. A profitable way to spend a rainy afternoon is to create a spreadsheet by plugging in the annual rates of return of all funds offered in your retirement plan — both those you have money in and those you do not. Try to go back 10 years. Identify each fund and then turn on the graphing capability of your spreadsheet software (which you may never have had an excuse to use). My
favorite graph (shown below) illustrates a ten-year lookback
of the following: an S&P 500 index fund, a small company
index fund, and a foreign index fund. Year to year, these different
types of funds vary dramatically. It helps to see this diversity,
because if you plot an average return for all five funds combined,
you wind up with the straightest line on the graph.  Graph the funds in your plan, or ask that it be done for you, and see how it influences your thinking. Past winners are often losers in a coming year. It is impossible to know what will be the leading performer tomorrow, and the chart you create is a graphic reminder of this fact. A picture says a thousand words. Another story the graph will tell you is that spreading money across different types of funds is your “least regrettable” course of action. Even though it goes against intuition, the graph will also indicate that investing more in the best performer over the past few years is probably NOT the way to go. Consider the performance of small companies funds. Since 1926, small companies (defined as having less than $200 million in stock values) have outperformed large companies by 4.3 percentage points per year. In 1991, when small companies as a group were up 45%, we saw a brilliant flash of this performance, but since then small-caps have not lived up to their historical superiority. Until now. They are surging again as we speak. What does the graph say about your own plan’s mix of investment offerings? Remember: It is the type of fund that determines most of performance — not the stock-picking skills of the managers. If you want a smoother path, you might adopt the approach of my options trader friend and construct what would essentially be the total stock market by choosing an even mix of offerings. The “Path of Minimum Regret” is one of my favorite terms, because it describes so eloquently the objective of investors who know they are exposed to risk when investing in stock funds. According to my friend the options trader, Minimum Regret Theory is an actual discipline of statistics used in the higher math of that arcane science. Fortunately for us, we only have to know some simple arithmetic to use this theory. It can help us sift through our investment options and arrive at an informed decision with regard to our mix. Spend a little time at the end of the year with the type of graph I’ve suggested, and you will start the New Year with important new insights into how to grow your retirement savings.
The Pension Dynamics web site is at www.pensiondynamics.com. There is a lot of helpful information at this site regarding 401(k) plans. We also have been writing a column every Monday for the Contra Costa Times newspaper. Archives of all past columns can be accessed by clicking the “This Weeks 401(k) News” icon on our home page. It’s great entertainment. Check it out. For those of you who may have old rollover IRA’s from previous companies, we are going to be introducing a new Internet product. This innovative software will use Natural Language Processing (NLP) similar to that used by “Ask Jeeves.com.” This means that you will be able to type in questions in plain English and the software will recognize the word sequence to automatically trigger correct answers. This is artificial intelligence at its best. Why do we apply it to rollovers? Because many people have many questions and experience trouble finding objective information. In addition to the artificial intelligence, we plan to offer real intelligence as well. By that we mean actual people who talk on the phone and can meet in person to assist you. This site will accomplish the following:
To date, we have not offered any resource for IRA assistance, because 401(k) plans have kept us too busy. Compared to 401(k) plans, working with IRA’s is like transporting bullfrogs in a wheelbarrow. The Internet, however, creates a window of opportunity. We can offer an advisory service that makes economic sense and that meets a Pension Dynamics standard of value.
With tax season upon us, it’s time to consider if we are doing all we can to minimize the bite. Here’s one way that many people who itemize overlook—donate your old clothing and household goods to a qualified charity such as Goodwill, Girl and Boy Scouts, Red Cross, Salvation Army, Amvets, and churches and synagogues. Here’s how and why:
To be sure, there’s some paperwork involved, but a 33% return on a few hours work is a pretty good return indeed.
If you’re thinking about changing jobs (one in three Americans did in 1999), you may also be thinking about cashing out your 401(k) account. Research shows that over the last three years about one in four job changers took distributions, paying taxes and penalties in the process that reduced their stake by as much as half. It seems that people do this under the assumption that taking a distribution won’t do their investment plan much harm. They reason that they have plenty of time to make it up. Bad idea. Consider that even a small distribution—say $10,000—earning a conservative 10% will generate nearly $175,000 in 30 years. That’s a huge hit to take for the sake of putting $5,000 in your pocket after taxes and penalties. Resist temptation. Consider the following options:
Indexes Prime Rate - 8.75% Fixed Mortgage 30 Year - 8.13%, 15 Year - 7.77% Home Equity Loan 9.15% Automobile Loan 8.58% Internet Sites Dow Jones Average History
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