Unhealthy Investment Attachments

Have you ever made yourself suffer through a bad movie because, having paid for the ticket, you felt you had to get your money’s worth? Some people treat investments the same way.

Behavioral economists have a name for this tendency of people and organizations to stick with a losing strategy purely on the basis that they have put so much time and money into it already. It’s called the “sunk cost fallacy.”

Let’s say a couple buys a property next to a freeway, believing that planting trees and double-glazing will block out the noise. Thousands of dollars later, the place is still
unlivable, but they won’t sell because “that would be a waste of money.”

This is an example of a sunk cost. Despite the strong likelihood that you’ll never get your money back, regardless of outcomes, you are reluctant to cut your losses and sell
because that would involve an admission of defeat.

It works like this in the equity market too. People will often speculate on a particular stock on the basis of newspaper articles about prospects for the company or industry.
When those forecasts don’t come to pass, they hold on regardless.

It might be a mining stock that is hyped based on bullish projections for a new tenement. Later, when it becomes clear the prospect is not what its promoters claimed, some
investors will still hold on, based on the erroneous view that they can make their money back.

James Lange, Lange Financial Group, Pittsburgh, Investment

The motivations behind the sunk cost fallacy are understandable. We want our investments to do well, and we don’t want to believe our efforts have been in vain. But there are ways of dealing with this challenge. Here are seven simple rules:

  1. Accept that not every investment will be a winner. Stocks rise and fall based on news and on the markets’ collective view of their prospects. That there is risk around outcomes is why there is the prospect of a return.
  2. While risk and return are related, not every risk is worth taking. Taking big bets on individual stocks or industries leaves you open to idiosyncratic influences like changing technology.
  3. Diversification can help wash away these individual influences. Over time, we know there is a capital market rate of return. But it is not divided equally among stocks or uniformly across time. So spread your risk.
  4. Understand how markets work. If you hear on the news about the great prospects for a particular company or sector, chances are the market already knows that and has priced the security accordingly.
  5. Look to the future, not to the past. The financial news is interesting, but it is about what has already happened, and there is nothing much you can do about that. Investment is about what happens next.
  6. Don’t fall in love with your investments. People often go wrong by sinking emotional capital into a losing stock that they just can’t let go of. It’s easier to maintain discipline if you maintain a little distance from your portfolio. This is one of the huge values a fiduciary advisor can add to your portfolio.
  7. Rebalance regularly. This is another way of staying disciplined. If the equity part of your portfolio has risen in value, you might sell down the winners and put the money into bonds to maintain your desired allocation.

These are simple rules. But they are all practical ways of taking your ego out of the investment process and avoiding the sunk cost fallacy.

There is no single perfect portfolio, by the way. There is, in fact, an infinite number of possibilities, but based on the needs and risk profile of each individual, not on “hot tips” or the views of high-profile financial commentators.

This approach may not be as interesting. But by keeping an emotional distance between yourself and your portfolio, you can avoid some unhealthy attachments.

Save

Save

Net Unrealized Appreciation (NUA): Don’t Pay More Taxes Than You Need To

Net Unrealized Appreciation (NUA) Don’t Pay More Taxes Than You Need To, James LangeSome employees have Stock Options, or the option to buy the stock of the company that they work for within their retirement plans. A unanimous Supreme Court decision in 2014 might discourage employers from offering their employees a stake in the business in future years, because they can now be held liable if the value of the stock drops. Employers can now also be held liable under insider trading laws for certain actions they make within the retirement plan, with respects to company stock.

But what if you do happen to have some company stock in your retirement plan? If you do, be sure to read Chapter 9 for some very important tax planning tips! When you retire and take a lump sum distribution from your retirement plan, the distribution may include employer stock that is (hopefully) worth more than the fair market value at the time it was purchased in your plan. The difference between the value of the company stock at the time you take your lump sum distribution and its value at the time it was purchased is called Net Unrealized Appreciation (NUA).

If you own company stock within your retirement plans, you should make sure that you understand Net Unrealized Appreciation (NUA) rules outlined in Chapter 9 before you roll over or take distributions from the plan. Many financial advisors don’t understand these rules and, if you don’t, you could end up paying significantly more in taxes than you need to. This is especially true if the company stock in your 401(k) has increased in value!

Stay tuned for an update on our classic case study of Eddie & Emily from Chapter 10!

– Jim

Jim Lange A nationally recognized IRA, Roth IRA conversion, and 401(k) expert, he is a regular speaker to both consumers and professional organizations. Jim is the creator of the Lange Cascading Beneficiary Plan™, a benchmark in retirement planning with the flexibility and control it offers the surviving spouse, and the founder of The Roth IRA Institute, created to train and educate financial advisors.

Jim’s strategies have been endorsed by The Wall Street Journal (33 times), Newsweek, Money Magazine, Smart Money, Reader’s Digest, Bottom Line, and Kiplinger’s. His articles have appeared in Bottom Line, Trusts and Estates Magazine, Financial Planning, The Tax Adviser, Journal of Retirement Planning, and The Pennsylvania Lawyer magazine.

Jim is the best-selling author of Retire Secure! (Wiley, 2006 and 2009), endorsed by Charles Schwab, Larry King, Ed Slott, Jane Bryant Quinn, Roger Ibbotson and The Roth Revolution, Pay Taxes Once and Never Again endorsed by Ed Slott, Natalie Choate and Bob Keebler.

If you’d like to be reminded as to when the book is coming out please fill out the form below.

Save

John C. Bogle – A Financial Industry Giant Addresses Congress

John Bogle, The Lange Money Hour, James Lange, Pittsburgh, PA Wednesday, October 1, 2014Join us this Wednesday, October 1 at 7:05 p.m. on KQV 1410 AM for The Lange Money Hour, Where Smart Money Talks.

Program also streams live at www.kqv.com

Encore presentations air on KQV EVERY SUNDAY at 9:00 a.m.

The three legs of America’s retirement system are shaky, neither structurally efficient nor fiscally stable. That’s what the U.S. Senate Finance Committee heard on September 16, during testimony by a man Fortune Magazine labeled one of four giants of American Finance: John C. Bogle, founder and now retired CEO of the Vanguard Group, the world’s largest mutual fund company, with more than 3 trillion dollars under management.

To hear why Mr. Bogle believes the situation is so precarious, tune in tomorrow evening at 7:05, as The Lange Money Hour welcomes him back to the show.

Over the course of his 63-year career, Mr. Bogle has changed the face of investing. A pioneer in the concept of index mutual funds, collective portfolios of stocks that mimic the movement of a defined market sector rather than a selection of individual companies, he is credited with creating the first index fund available to individual investors, the Vanguard 500.

Mr. Bogle has written a dozen books, including his 1994 bestseller Bogle on Mutual Funds to most recently The Clash of the Cultures: Investment vs. Speculation. At 85, he remains an active industry observer, appearing regularly on national financial media outlets. He recently described the personal mission he has set for himself in his retirement – “to speak out for truth and integrity and character in the world of finance, striving to build a better world for investors—honest-to-God, down-to-earth human beings who deserve a fair shake.”

You can watch his 6-minute Congressional testimony here:

http://johncbogle.com/wordpress/2014/09/17/testimony-before-the-senate-finance-committee-september-16-2014/

We’re honored to have Mr. Bogle back as a guest on The Lange Money Hour. Please plan to join us Wednesday, Oct. 1, 2014 at 7:05 on KQV 1410 for an interesting and informative hour. The program will also stream live at www.kqv.com.

If you can’t tune in October 1, 2104, KQV will rebroadcast the show at 9:00 a.m. this Sunday. You can also access the audio archive of past programs including written transcripts on the Lange Financial Group website, www.paytaxeslater.com. Click on RADIO.

Finally, mark your calendar for Wednesday, October 15th at 7:05 p.m., when Pittsburgh City Controller Michael Lamb will join us for the next new edition of The Lange Money Hour.