Friday, January 30, 2009

Feel Like Gambling With Your RRSP's

So Dubya is now just a cocktail joke and Barack Obama wants to install a basketball court at the White House (which as a devoted hoops fan is just great). Can you imagine the odds on that back in 2000 when Dubya "won" his first election.

It's the height of "RRSP season" and for some reason, the phones are not exactly ringing off the hook with people wanting to buy. While I am not surprised, I am somewhat disappointed that people have not seen the wisdom in "buying gas at 80 cents per litre instead of $1.30 per litre". Perhaps more disconcerting to me is that in speaking with other advisors, many of them have exited the RRSP stage for the safety and security of more traditional insurance products. As with people who suddenly believe they don't need to save for the future, the plight of these advisors may be equally bleak.

Being a contrarian means going against the herd and buying when others are selling. Forgetting the past and the future means we are moving forward without direction. The future will come - the only difference is that some people who have not planned for it will suffer for that sin. The people who continue to plan will ultimately reap the most rewards.

Whenever people complete a "risk tolerance" questionnaire, there are the inevitable people who say they want the highest returns with no risk. Let me just say this - there are no high returns without risk. The problem is that most risk tolerance questionnaires fail in one very simple area. When investors have never truly lost an appreciable amount of money and you ask (by percentage), how much they could stand to lose, the figure is always much higher then reality. Now we go through a dramatic market selloff and human nature says that if I can lose 25% once, I can lose it again. Of late, the answers to some of those questions have revealed that people are very nervous and uncertain of their future.

In some respects this is beneficial to the future as people will become more attuned to their beliefs. There will be fewer people expecting their advisor to "handle things" and questioning the results of "only a 10% return" this year. The best advice for people to remember is this - stick with your target and don;t deviate unless something happens that necessiatates a change.

I think it's critical to develop an asset allocation target. The portion of your portfolio that should be in equities depends on two things - your willingness to take risk and your need to take risk. Your need to take risk is driven by how close you are to achieving your goals. If retirement is your goal and you have a lot saved up with low living expenses, you probably want a very conservative portfolio of, say, 30% in equity funds (stocks). But if you are far from this goal, then you will either need to take more risk, or alter your goals.

While I am a believer that you can set your allocation based on taking a risk profile survey, research shows how we feel about risk is very unstable over time. In other words, once you do it - then stick to it. In other words, the more we change our allocation targets, the lower our returns tend to be.

You may be feeling what I'm feeling right now. The pain of watching our portfolios decline will do one of two things;
  1. It may drive us to take more risk to try to get back our losses as quickly as possible. Research indicates that people are generally risk averse, then do a 180 and become risk takers when faced with painful losses. Increasing our stock portfolios after this loss may be the Las Vegas equivalent of doubling our bets at the blackjack table to try to get back some hefty losses. We don't want to become the guy who loses most of his fortune and promises to stop as soon as he gets it back.

  2. It may make us go from being fairly aggressive to ultra conservative. However, that means selling cheap and never buying back in. In following this strategy, it will take several years (perhaps 6-10) to recover and to get back to their original positions.

To all those people who think they need to adjust their plans based on the market, may I ask a simple question - do you determine your future or is your future determined for you? By reacting negatively, you are allowing the direction of the stock markets to predict your retirement goals. Stick with your long term goals and then gradually get less aggressive as you get closer to reaching your goals.

You are doing what Warren Buffett once said: "Be fearful when others are greedy and greedy when others are fearful." This is a really good thing, but let's not go overboard on the fearful or the greed.

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