Financial Blueprints

If you had a piece of land and wanted to build a house on it, you wouldn’t just dig a hole in the dirt, pour some concrete into it and start building room by room, hoping to one day end up with your dream home, would you? Most likely you would do some research, consult with friends and family and find a professional with whom you could sit down to define your vision and draw up a set of plans to guide you. With the plans in place, you would then seek out an experienced and well-regarded builder (perhaps the same person who drew up the plans, perhaps not) to execute them. Yet so often, when it comes to planning their financial future, including eventual retirement, people do exactly the former by diverting their hard-earned money to a series of so-called investments in a haphazard way with no professional help or pre-defined plan to guide them. 


The house building analogy is one that we use quite often in our practice to help drive home the importance of planning, but there are many more that we have heard through the years that are equally effective in painting the picture for clients. A favorite of a former colleague was more of a travelling comparison that essentially boiled down to not starting a long journey without mapping out the route first. The list of potential metaphors is long and which one resonates with each person is not important. What is important is why advisors who are committed to financial planning feel so strongly about the effects of sound planning on the client’s ultimate outcome, that they deem it necessary to express this relationship in any way they can in order to highlight the point.
To those of us who believe that having a well-thought-out plan in place is not only helpful, but essential in determining financial outcomes for clients, the plan is not simply a collection of statistics, but a barometer that defines, in advance, what steps will be taken under different market conditions. A guide for decision making not based on how we ‘think’ or ‘feel’ during the stresses or euphoria of up and down markets, but on what  effects these steps historically have had or likely will have on the client’s individual circumstances.
We regularly cite the statistics of lagging average investor returns versus those of the overall market, and have addressed some of the potential causes in previous blog posts (see “It’s Different This Time”, July 27, 2012). And, as firm believers in many of the main principles of behavioral finance, we do not see these statistics as particularly surprising or remarkable. On the contrary, we find the forces of herd mentality, loss aversion and the like to be expected responses to volatile market conditions. Such forces need to be addressed, accounted for and counteracted by planning for them in advance so that important financial decision are not being made during times of high stress and market uncertainty. Volatility is a natural function of financial markets (the sensationalist nature of financial news reporting during highly volatile conditions notwithstanding), and an investor armed with the confidence of a pre-determined action plan is much more likely to avoid the costly mistakes that lead to severe underperformance over time than an investor without one.
There have been roughly 15 recessions in the past 100 years in the U.S., meaning one every 6-7 years or so. Clearly not an unusual event, and as anyone who studies economics or markets knows, a necessary yang to the yin of expansion. And because of the irrational exuberance (as Alan Greenspan so eloquently put it) that so often occurs, particularly in the late stages of economic expansions, the resulting recessions can often be equally powerful. The pendulum swings too far in either direction as it were. 
And, while these swings are perfectly natural, each has a distinctly different feel while it is happening- a feel that, to the untrained actor, seems entirely new and unnatural. What we see then is the investor who has built his foundation on little more than some internet research and the advice of well meaning friends and family, suddenly second guessing his methods and likely the overall health of the system as a whole. The steps that follow range from discontinuing contributions to outright paralysis to conservative repositioning and often culminate in the dreaded “I’ll just get all the way out until the market turns around” reaction.  This last response generally results in locking in losses at the worst possible time, likely missing the customary bounce off the bottom and effectively torpedoing the long-term return potential of his portfolio.
This is not to say that to the investor who has properly planned for and been coached to expect the volatility that comes with the inevitable recessionary downturn, it doesn’t also feel new and unnatural. However, the confidence that has been created through the execution of a carefully produced financial plan, acts as a bastion against the natural feelings of fear and loss aversion that set in during such times.  What’s more, when an investor is not clouded by feelings of fear and doubt, she can see the recessionary environment clearly for what it is, a small moment of opportunity.  By continuing to contribute to investments and rebalance current positions during market downturns and intervals of great volatility, the planning client typically takes advantage of a buying opportunity, purchasing high-quality assets at depressed prices. This effectively lowers her overall investing costs over time, resulting in potentially higher returns in the long run.
In our practice, we believe in the the virtues of comprehensive planning far beyond the effects on just the investment piece of the financial puzzle, and will continue to preach the gospel of planning to all of our clients going forward. For everyone else, you might want to make sure your foundation is solid before starting on that third-story addition.




The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.