Can you condense your many essential financial and legal documents into one portable file container? With many records now stored online, this goal is more attainable than ever.
The following ideas can help you pare down the paper documents that represent your financial life. When everything is sorted, clearly labeled and located in one place, you will have created a clear path for yourself and your family members to find your important financial and legal information. (An expanding file with a hinged lid and handle should hold most of the documents mentioned below.)
Consider what you would need if you were going to be away for a couple months with no access to your desk, or if your family needed to access information in your absence. No one is immune to the possibility of a lengthy power outage, fire, flood or other emergency situation. With all your key records in one portable container, you can be prepared for the unexpected.
What to Include
In general, what you need is not the detailed documents themselves but enough information to find the details should the need arise. For example, rather than including complete copies of your auto, home and life insurance policies for the past 10 years, what you or your family may need most are policy numbers, contact information for any agents you work with and your insurance-related login IDs. In many cases, just a couple sheets of paper should make it possible to find almost any information you need about your policies.
This list varies for each individual but offers a starting point of documents you should reference, including contact and account information:
Also consider storing the following:
Another useful step is to copy the front and back of every card you keep in your wallet: credit cards, IDs, insurance cards and so on. Having this information stored with the rest of your important documents will be helpful if your wallet is lost or stolen. It is a good idea to update these copies every year.
When sorting out your remaining files, consider two more categories:
Essential but rarely needed: It may be best to use a safe deposit box to hold items that must be retained for the long term, documents such as military discharge papers, divorce or adoption papers, prenuptial agreements, real estate titles and business succession plans.
Less essential: After you sort through all your files, you will still have some documents in your filing cabinet such as home improvement receipts, warranties, past medical records, old tax returns and other items that may be needed at a later time.
Ready and Set to Go
Think of your new filing system as a dynamic resource for you and your family. It should be kept in a secure location known only to you and your family, but still readily accessible, if and when needed. And if you prefer to travel even lighter, several online services provide storage and organization of scanned documents as an alternative to a physical filing system.
Copyright © 2013, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
It’s my experience that there are two keys to being able to maintain control over those urges that get investors into trouble. The first is to understand financial history. That means knowing that stocks are high risk investments, subject to large losses (we’ve had three bear markets with losses of about 50 percent or more in the last 40 years), and serious crises come with great frequency. Forewarned that regular crises are the norm in investing enables you to be emotionally prepared to deal with them.
The second key is that in order to deal with the many crises, and the bear markets that accompany them, you have to make sure that you don’t take more risk than you have the ability, willingness, and need to take. As you’ll see, finding this sweet spot is more art than science.
The willingness to take risk
The first step in understanding your willingness to take risk is to take what I refer to as the “stomach acid” test. Ask yourself this question: Do you have the fortitude and discipline to stick with your predetermined investment strategy when the going gets rough? When the only light at the end of the bear market tunnel seems to be the proverbial truck coming the other way, will you be able to avoid panicked selling? Will you be able to focus instead on rebalancing your portfolio back to its targeted asset allocation? That will require you to buy stocks (which have been crashing) and sell bonds (which likely have been rising in value).
As Warren Buffett once noted, successful investment management depends to a large degree on your ability to withstand periods of stress, and overcome the severe emotional hurdles investors face during bear markets. It's best, then, to assess your maximum tolerable loss along with your maximum equity exposure, and then set your investing plan accordingly. And while your plan shouldn’t be based on the worst possible outcome, you should also have contingency plans that can be adopted should losses become excessive.
It’s been my experience that most investors and advisers employ a tool like this one in strategizing and deciding on an investment plan. And while it’s a useful tool, there are several issues we need to address to make sure you find the right answer.
Avoid being too overconfident
The first has to do with the fact that far too many investors are subject to the all-too-human trait of overconfidence. It doesn’t matter what the question is, when asked if we are better than average, about 80-90 percent of people believe they are better than average. While that likely won’t hurt you if you believe that you’re a better than average driver, it can cause you to take more risk than your stomach can actually handle when it comes to investing. The result will be that when crises occur, your stomach will take over from the head and start making decisions. And stomachs rarely make good decisions. Thus, it’s critical that you don’t overestimate your ability to absorb panic that bear markets create in all of us. Don’t lie to yourself (or your adviser), as you’re the one who will have to live with the consequences. To help get this right, think about how you felt during the most recent crises we faced, including not just the bear market of 2008-09, but the European crisis of 2011, and the recent budget and debt ceiling debates.
Pass the sleep well test
The second issue is that you not only have to pass the “will not panic and commit portfolio suicide by selling during a bear market” test, you also have to have a clear enough head to rebalance by purchasing more equities just when the world looks darkest. And beyond that -- you should also be able to pass the “sleep well” test. In other words, if you would be tempted to panic and sell whenever a 30 percent loss in your portfolio occurred, and would start to lose sleep, then it’s the sleep well level that should drive your decision. Life’s just too short to not enjoy it.
Consider how the question’s framed
The third issue relates to a framing problem. Behavioral studies have found that how a question is framed can greatly influence your answer. Rationally, since the questions are really the same, the answers should be the same. Yet, we find that how a question is framed can change the outcomes considerably. Consider the following example for Jaswon Zweig’s book “Your Money & Your Brain”:
One group of people was told that ground beef was “75 percent lean.” Another was told that the same meat was “25 percent fat.” The group that heard about fat estimated that the meat would be 31 percent lower in quality and taste 22 percent worse than the lean group predicted.
It's my experience that how the risk tolerance question is framed has a great impact on the answer. To illustrate the point, let’s assume you have a million dollar portfolio. Based on your answers to the “I won’t panic”, “I will rebalance”, and “I will sleep well” tests, let's assume that the maximum loss you want to face is 25 percent. That translates into a maximum equity allocation of 60 percent. However, if you frame the problem in a different way, it’s likely you’ll get a different answer. The right way to frame the problem isn’t with the use of percentages, but with dollar amounts. With that in mind, now consider the answer from the following perspective.
Assume you begin with a portfolio that is $600,000 in stocks and $400,000 in bonds. Now assume the stock market loses 50 percent and bonds have increased 12.5 percent. Thus, the portfolio is now at $750,000, with $300,000 (40 percent) in stocks and $450,000 (60 percent) in bonds. That's a loss of $250,000. And now it’s time to rebalance. To restore your portfolio to your target of 60 percent stocks/40 percent bonds you’re going to have to buy $150,000 of stocks (that have just lost 50 percent and some guru is forecasting it will drop another 50 percent) and sell $150,000 of your safe bonds that actually have risen in value. Will you actually be able to do it? Ask yourself. My experience is that investors become more conservative when asked the question in actual dollars versus percentages.
Ability and need for risk
Determining your risk tolerance requires a great deal of planning and understanding. As Napoleon said: “Most battles are won or lost [in the preparation stage] long before the first shot is fired.” Avoid your
Copyright © 2013, The BAM
Behavioral finance is a fascinating field, providing us with many insights into investor behaviors that help explain many of the anomalies that financial theory cannot explain on its own. It also helps explain many of the mistakes investors make. Among the most common of errors is overconfidence. Even concerns over status can lead to suboptimal investment decisions. For example, given the persistently poor results of hedge funds, the desire to be a member of an exclusive club could explain investments in these vehicles.
Gunther Loffler, author of "Tower Building and Stock Market Returns," hypothesized that the construction of towers (large scale projects such as the World Trade Center) could provide insights into stock returns. The premise is that tower building could be a reflection of periods in which over-optimism has led to overvalued stock markets, or it helps to identify times of low risk aversion -- low risk aversion leads to low risk premiums and the funding costs for large-scale projects are lower. Low risk premiums predict low future stock returns. And, of course, status could play a role in the building of towers. While Loffler doesn't mention it, the Empire State Building, the construction of which began just as we were entering the Great Depression, could have been the poster child for the story.
Loffler tested these hypotheses by examining whether tower building was associated with lower future stock returns. Building activity is measured through construction starts of towers that exceed a trailing 30-year mean tower height. The choice of 30 years was based on the long cycles of building projects.
As an example illustrative of both interpretations, Loffler offers the Chicago Spire, which had a planned height of 609 meters or 2,000 feet. Construction of the Chicago Spire began in June 2007, a time in which credit spreads were low and valuations were relatively high. He also noted that the Chicago Spire was representative of the many high-rise buildings planned that year -- the number of towers taller than 100 meters on which construction began was more than twice the annual average of such construction starts over the prior 20 years. (Note, in 2008, facing the effects of a declining economy, the Spire tower project had to be suspended. The project was officially cancelled in December of 2010.)
Data on towers was obtained from the research database of Emporis, a private information provider. Loffler included buildings that were started to be built but were never finished, thereby avoiding a possible selection bias that might arise if only finished buildings were studied. He also only considered private (non-government) buildings as government building activity should be less sensitive to market conditions, and may even be countercyclical if governments invest in buildings to smooth business cycles. He organized the data based on start of construction. The starting point for the data was 1871. The following is a summary of his conclusions:
The bottom line is that as surprising as it may seem, private tower building activity has provided us with information on future stock returns. And there are logical explanations for the findings (wide spread over-optimism, easy credit conditions, and low risk premiums). While I wouldn't recommend using this indicator as a means to time the market, it might serve a useful purpose by acting as a check on your own optimism about future stock returns -- preventing you from getting caught up in the herd and falling prey to the "this time it's different" mentality that can infect investors.
Copyright © 2013, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.