It was the Summer of 2008. I was a few years out of business school, a few years married, and I’d passed the CPA exam. I’d just started my MBA. I had a good accounting job at a large insurance company. And, up until this time, the world of finance had pretty much lived up to what I had been taught in college. My extra cash was in a 1-year certificate of deposit earning 6.25% annually. My retirement savings were stashed in a “Target Retirement Date” fund that was yielding decent returns and was automatically rebalanced based on an age-appropriate investment allocation. I owned a 1-bedroom apartment (recently converted from co-op to condo). And I’d been able to put away some cash savings with an eye on eventually trading up to a house. I felt financially and personally responsible and in control.
I had no idea that my most basic financial beliefs were about to be dashed to bits.
I came of age – financially speaking – during the 2008-09 financial crisis.
In August of ’08, I was working in a department that handled my company’s public reporting. We wrote the earnings reports, composed the quarterly Management Discussion & Analysis, and compiled the annual 10-K. In my particular role, I was responsible for preparing a report on unrealized investment gains and losses on fixed income investments. In other words, my report was supposed to show management whether our fixed income investments (for example: bonds, mortgage-backed securities, collateralized debt obligations, and so on—does any of this sound familiar?) were gaining or losing value. I still remember handing my first report to my new manager. And I still remember the look on her face when she reviewed it. She took a quick glance, handed the paper back to me, and asked me to look at it again because the numbers didn’t seem right.
But they were. I had properly calculated the losses on the report. And these losses were just the beginning.
I had actually set out to write this week’s post about my retirement fund investment allocation. Following my last blog post about budgeting and values-based goal setting, a friend of mine gave me some helpful feedback on how he views his monthly budget. And since we talk about financial stuff from time to time, he also asked me what the investment allocation in my retirement funds is looking like these days. And it struck me, suddenly, that there were two things I needed to do: (1) Take a much-needed look at the investment allocation in my retirement funds, and (2) blog about it.
My investment allocation is… flawed. I am embarrassed to admit how bad it is. But then again, I don’t think this blog will be worth much if I can’t be honest with my readers. I could ask myself how it’s possible that I – the “planning-est” person that I know – have let my retirement portfolio languish in subpar investments for such a long time. But really, I don’t have to ask.
I already know the answer: Fear.
I’m not sure how (or if) I will be able to get past my hangups especially when they’ve been with me for so long. But if I’m to have any chance in hell of facing my financial fears, I need to begin by understanding them. Where did this fear come from, and why? Was it justified? Is it productive? And what can I do to move forward? I need to start at the beginning – at the dawn of the Great Recession.
If you somehow came out of the Great Recession unscathed, then feel free to skip the rest of this post. But if you are anything like me (and perhaps the lion’s share of our generation), you may still have some healing to do. Join me – won’t you? – for this painfully honest self-examination.
The “Risk – Reward Relationship” — and other lies I’ve been told
The Great Recession was a disturbing time for me for plenty of reasons. But let’s start with how it brought an abrupt end to my financial naiveté by simultaneously violating most of my basic notions of how the financial world worked. Now, my perspective on these things was not totally uninformed — I’d graduated business school with a double-major in Finance and Accounting, after all. Thanks to that coursework, as well as a few years of adulting, I had come to understand a series of “truths” about the way things worked. These “truths” included:
- There is such a thing as a “risk-free rate,” and it’s the rate you can earn on US Government bonds.
- Risk has a direct relationship to reward: If you take on less risk, you will realize a lower return. Greater risk will yield a higher return.
- If you do a good job of diversifying your portfolio, you dramatically reduce the overall risk of your investments.
- You can expect the stock market to earn about 8% a year.
- The value of Real Estate goes up as time passes.
- You should start saving for retirement as early in life as possible.
Over the course of the next few years, each of these “truths” was challenged in various ways. As the Great Recession unfolded—in connection with the Subprime Crisis, the government bailouts (Fannie, Freddie, banks, auto makers, and so on), the collapse of the stock market, the soaring unemployment, the erosion of families’ retirement funds and savings, the dramatically lower real estate values, the credit crunch, and countless other devastating events—I felt more and more like everything I’d been taught was a lie. I felt betrayed and frustrated.
My husband and I had been playing by the rules! We had worked hard to squirrel away some cash – and yet, when our CD came up for renewal, I realized that we basically couldn’t earn any interest at all on those savings. I’d invested my retirement savings in a diversified fund, but my 401(k) lost so much money that I might as well have not invested at all for my first 3 years of work. We bought our home – modest though it was – right out of college, only to sell it at a loss several years later. Our attempts to be financially responsible had gotten us nowhere at best, and had actually done us direct financial harm in several cases.
De-Risking my Reward
Amazingly, this period in our lives was not a complete loss. Some of our efforts were validated. We were able to build our credit by paying all of our bills on time. We paid off our student loans and mortgage, and managed to become debt-free. We saved enough for a down payment on a house. We worked hard and earned trust and respect at our day jobs. In these ways, we actually did continue to invest during this time period. In contrast to the chaotic world around us, however, this form of investing was of the lowest degree of risk humanly possible. My only bets were on “sure things.”
So, after being burned by the financial risks that we’d taken (however well-intentioned), and after achieving some degree of validation through our more conservative actions, I “learned” that my time and money achieved the best returns by taking the lowest degree of risk. I preferred to earn a guaranteed return by prepaying my mortgage, as opposed to offering my hard-earned dollars up to the whims of the stock market. The hope of earning a higher return wasn’t a worthy tradeoff; I had very little to show for all my prior hope.
In other words, I “un-learned” the inverse relationship between risk and reward. Lower risk, for me, dramatically increased the chances that I’d get any reward at all. And that was the important thing: Not failing. Not losing what I had. And thus, perhaps it is no surprise that I’ve ended up where I am now. With my head buried in the sand, financially speaking. My fear of loss has shaped my investment decisions (or the lack thereof).
Not So Sure About Sure Things
Admittedly, there was also some part of me that was intrigued by watching the world burn. I had never in my life been more engaged with current events. I started watching the markets every day and reading the financial news. I also became more interested in hearing out contrarian viewpoints. This broadened my worldview; prompted me to ask new questions about what was happening, and why. And it motivated me to seek out the answers.
But I didn’t find many answers. Instead, I watched as once-respected “experts” were reduced to jokes. I read about financial mavericks who claimed to have the answers, and were later revealed to be liars or criminals. I tried to analyze current events using basic financial mechanics and economic theories, only to find that these concepts were suddenly invalid in times of market stress. In the process I became more cynical, and somehow even less trusting of the system that had “betrayed” me.
What good are experts and theories if they don’t hold up when you really need them? And more importantly, how can one possibly make prudent and reliable financial decisions if the rules can be changed on them at any given time?
And so, here I have remained. I haven’t moved my 401(k) investments. I haven’t rebalanced my portfolio. Sure, I’ve been contributing enough to my 401(k) to maximize the employer match. I learned long ago that you never say “no” to free money! But that’s pretty much it. I moved most of my money into low-risk fixed income funds in late 2009, and I have been expecting another huge market dip ever since. It hasn’t happened, of course—even with all the flaws still present in our economy—and I have missed out on years of market appreciation.
I am petrified of making a (or, another) bad decision. I don’t want to lose more of my family’s money. So I’ve been focusing on “sure things.” Like paying down the mortgage on our house. Like building up our emergency fund. Like replacing the aging major appliances in our home before they fail.
These are not bad ideas. But these things will not help me send my son to college. Nor will they help me feed myself in retirement.
Don’t Judge a Choice by its Outcome
I took AP Statistics in high school. I know that a coin is just as likely to come up heads as it is to come up tails. Similarly, the logical part of my brain knows that Market risk, which is so scary to me, is not inherently negative. It is just randomness. And it can be at least partially reduced through portfolio diversification and hedging. Even then, if we are invested in a well-diversified portfolio that is appropriate for our risk tolerance, the market can – and will – fail us from time to time. It’s statistically certain that there will be dips, and drops, and the occasional meltdown. When this happens to me, it is not a shortcoming of mine, but of the market. Therefore, it is not something to fear—it is something to expect. And when it does happen, it is simply something to wait out.
Rationally, I know this. But emotionally–I’m not there yet. I know that my actions haven’t been logical, but I haven’t found the right way to convince myself of it. I’m still trying to find an argument that works.
Say, for example, I do some research and decide to move some of my retirement money into new investments. Then, the market does something crazy the very next day, and suddenly I’ve lost a bunch of money. I would feel 100% responsible! So I use this scenario to justify doing nothing at all.
But a more accurate analysis of the scenario I just described would be that my investments have failed me. And the really important point here is that updating my investment choices was still the right call, even though I ended up losing money. See, it’s flawed logic to judge your choices based on the outcomes. This is masterfully explained by Annie Duke (Thinking in Bets) when she tells us to imagine a time when we’ve run a red light. Does the fact that we didn’t actually cause an accident mean that it was the right choice? No – it was a reckless choice and bad choice. Similarly, we can make good choices that don’t always pan out the way we hope. But that doesn’t mean that they were bad choices.
As a Planner, I Can Finally Answer
So we will still lose sometimes, even when our decisions were the right ones. Taking action does not ensure an ideal outcome by any means. Nothing does, really. But it is still the best bet. And I end up in a position where I can say that I truly did try my best.
Being able to make this assertion is key, because it affects my mindset. And a shift in mindset, I’m finally realizing, will be my ticket out of my ostrich-like state. Something as simple as being able to claim that I tried my best instantly transports me from a place of shame to a place of power.
But what if my best isn’t good enough? My fear is quick to rear its ugly head. My cynicism is close behind. Again, I ask: “How can one possibly make prudent and reliable financial decisions if the rules can be changed on them at any given time?” And the Great Recession-era version of Erin begins, once again, to justify her own inaction.
But today, for the first time since 2008, I am feeling compelled to answer, and to rebut. Yes, the answer lies with mindset – but also, it is exemplified in the Financial Planning process.
Shut Up, 2008-Erin
The Erin from the Great Recession is afraid that another market meltdown will happen. Terrified of it, in fact. So much so that she is paralyzed investment-wise and won’t make any decisions at all, even to the detriment of her finances.
The me of today knows that another market meltdown will happen. I don’t know when, but I am confident that it will happen at least a couple times during my lifetime. My mindset has shifted from fearing unknowns to actually taking comfort in knowns. This may seem counterintuitive – why should this coming crash be a comfort? But the answer is simple.
Now that I know it, I can plan for it.
This is the value proposition of Financial Planning. A financial planner asks: “What are your plans for the future?” And then, a financial planner states: “Let’s assume that every single one of your plans gets totally f*cked. In fact, let’s brainstorm all of the ways that could possibly happen.”
Before long, you have a list of all of the things that could go wrong with your plans. For example, you could become disabled. The market could crash. College could cost twice what you expect it to. You could die. Social Security may not exist by the time you are ready to retire. And so on. Together, you list out all of the scariest and most devastating things that could happen.
And then, in a level-headed and logical fashion, you and your planner work together to plan ahead for each and every one of these possibilities. And when your Financial Plan is done, you have a comprehensive crisis-management plan for your life. You are prepared for the worst. And further, you can be sure that at least one of these things will happen. You don’t know which, or when – but you already have your plan.
You know that something will happen. And you are ready for anything, because you already have your plan.
There is going to be another market crash. What I need to do now is figure out, ahead of time, what my plan is: before, during, and after. Then, when the crash does happen, there won’t be much to do. I’ll just follow the plan that I already decided on. Because I’ve already prepared for the worst.
Of course, I’m not there yet. But over the next couple months, my personal goal is to finally face my retirement investments head-on. I will accomplish this by turning my financial fears into a Financial Plan. And I will share my progress with you as I do.
But hopefully this won’t just be about me reassessing how I’m invested in the context of the world we’re living in right now. It’s also about figuring out a way to put my fear aside and act on things mindfully, with presence, and in a way that makes me feel good about my decisions. And if I can talk myself out of this mixed-up state, maybe you can too.
Do you have a financial decision that you have been avoiding? Is there another gnarly topic that we can face together in a future post? Please leave a comment with any thoughts!