JEW Whitepaper 2010

BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vol.
1, Issue 1
Introduction
W
HEN YOU CONSIDER THE CURRENT ECONOMY, THE
last thing you are probably experiencing is “irrational
exuberance.” Federal Reserve Chairman Alan Greenspan was the
first to use this phrase in the mid-1990s. Only a few years later,
Amazon.com, once merely a retail book Recession Starts Taking a Toll:

company started in a garage, was trading at Will it lead to another crash?
$91 a share with a history of negative
earnings (MarketWatch, 2002). In other “Worries are building that today’s sagging
words, people were willing to invest in a economy may be on the brink of
company by purchasing stock that had and collapse.”
would continue to lose money. If you U.S. News and World Report
contrast this level of performance with that
of the average stock in the S&P 500, you The Death of Equities
can see how those Amazon investors were
gambling with their money in response to “7 million stockholders have defected
irrational exuberance. When Greenspan from the stock market [this decade],
coined the phrase, the stock market was leaving equities more than ever.”
Business Week
Investor behavior does matter, and it arguably poses the

greatest risk to successful long-term investment experiences.
booming, so few people were likely to Running Short of Cash

heed what we now recognize was a
warning. Shortly after he made the “The United States and its allies
comment, world markets slumped. scrambled to head off a global financial
disaster. Finance ministers from the
During global economic crises, we read
United States, Britain, France, Japan, and
alarming headlines. Consider the
West Germany met last week near
following:
Frankfurt to find a way to avert a global
economic collapse.”
Newsweek
BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vol. 1, Issue 1
These were not pulled from today’s headlines. They

come from November 1974, August 1979, and
December 1982 when investors were experiencing great
fear in the midst of bear markets. Fortunately, the
financial world did not come to an end at any point, not
in 1974, 1979, nor 1982. And though national and
international efforts certainly played a role in the
investors’ returns, what may have played the most
2431 Devine Street
Columbia, SC 29205 significant role were individual investors’ abilities to
888.799.9203 make logical decisions in the face of financial fear.
Investor behavior does matter, and it arguably poses the
For the complete article series greatest risk to successful long-term investment
or for more information about experiences. Furthermore, the outcomes of investor
the wealth management behavior are even more dangerous to the financial
services offered by J.E. Wilson
security of people transitioning into or living in
Advisors, please visit
retirement. This article is the first in a series about
www.jewilson.com . investor behavior and psychology, historical perspectives,
the importance of diversification, and possible solutions
to the challenges investors face.
®
by James E. Wilson, CFP
©Copyright 2010
All rights reserved.
Please feel free to pass on this

article for personal use.
However, no part of this
publication may be reproduced
or retransmitted for commercial
use in any form or by any means,
including, but not limited to,
electronic, mechanical,
photocopying, recording or any
information storage retrieval
system, without the prior written
permission of the authors.
Unauthorized copying may
subject violators to criminal
penalties as well as liabilities for
substantial monetary damages up
to $100,000 per infringement
including costs and attorneys’
fees.
2
Why is Investor Behavior So Important?
P ERHAPS THE MOST IMPORTANT INGREDIENTS TO long-

term financial security are the decision-making abilities and
behavior of the investor. DALBAR, Inc., a company that provides
standards, research, and ratings for those in the financial
industries, published a report in 2008 consider the following: assume an
that shows the effect of investor behavior investor had put $100,000 into an S&P
on financial investments. According to 500 mutual fund in 1988 and earned its
that study, the S&P 500 earned an average return of 11% between then and
annualized return of 11.81% during the 2007. Even after the bursting of the
20 years ending in December 2007, 2000 - 2002 Tech Bubble, the value of
which was a period of strong bullish that investment would have grown to
markets, while the average equity $806,231. Hampered by flawed decision-
investor only earned 4.48%. Despite the making abilities, however, the average
opportunities, in other words, the average investor actually achieved a 4.48% return
investor earned only 38% of the available during the same period. That hypothetical
return as a result of making poor investment of $100,000 would only have
decisions throughout the twenty year grown to $240,249. The behavior of our
period. To better understand the hypothetical average investor ended up
practical implications of these numbers, costing him a difference of over
$560,000.
Source: “Qualitative Analysis of Investor Behavior,” DALBAR, Inc, 2008

This is a loss of 69% of the available return of $806,231.
Unfortunately, most investors fall prey to a thought

process that prevents them from always making logical
decisions instead of decisions based more on emotional
responses. The consequences may mean the difference
between retiring with financial security, peace, and
2431 Devine Street confidence and the alternative of retiring in what would
Columbia, SC 29205 feel like relative poverty.
888.799.9203
This article is the second in a series of lessons about the
For the complete article series
or for more information about barriers investors face as they work to achieve financial
the wealth management security. The first article introduced the series, and the
services offered by J.E. Wilson next article will outline how investors are often their own
Advisors, please visit worst enemies.
www.jewilson.com .
®
©Copyright 2010

fees.
Next Issue: Your Portfolio’s Worst Enemy
2
Your Portfolio’s Worst Enemy
T
HIS YOUNG CENTURY HAS ALREADY FELT THE POPS and
drops of two investment bubbles – one in 2002 and the
other in late 2008 and early 2009. Some investors may have
mostly escaped the impact of one, or perhaps both of them, but
behavioral finance, a relatively new Emotionally driven behavior into
academic field, teaches us that investors perspective, future articles will attempt to
can still be vulnerable to the momentum explain some of the challenges presented
created by fear and greed, even if they are by psychological forces that impede our
not hit by each downturn in the market. financial success, and they will cover the
following aspects of investing:
In order for investors to continue to be
safe from this momentum, they have to  A historical journey to better
understand how their behavior impacts understand economic cycles;
portfolio performance. In their efforts to
achieve long-term security, they may find  Psychological tendencies and the
it helpful to recognize that during the challenge of overcoming these
extraordinary expansion of the housing tendencies to become good
bubble and the most recent sell-off in the investors;
stock market, many responded
emotionally and with at least some  How our financial survival depends
disconnect in logical reasoning. At an on our ability to identify these
extreme level, this disconnect can lead to challenges;
a suspension of the traditional benefits of
business acumen and fundamental and  Hard and fast solutions.
technical analysis. To help investors bring
the challenge of
Investors should understand how their own behavior

impacts portfolio performance.
This article is the third in a series about the barriers

investors face as they work to achieve financial
security. Previous articles introduced the series and
the importance of investor behavior. The next article,
included with this one, will provide a historical
perspective for investors.
2431 Devine Street by James E. Wilson, CFP

®
Columbia, SC 29205
888.799.9203

or for more information about
the wealth management
www.jewilson.com .
©Copyright 2010

fees. Next Issue: A Historical Perspective
Historical Perspective
E
VEN THOUGH EACH BEAR MARKET SEEMS UNIQUE,
investors can gain some perspective if they review the
similarities of bear markets over the last fifty years – a period
during which we have faced ten particularly challenging intervals
in market conditions, including the one
we are now experiencing. Approximately
every five years, the market enters a
period of correction that is a natural
process of the risks and rewards of
capitalism, and each time, we have
recovered from the slump in the cycle.
To better understand these patterns from

a historical perspective, consider three of
the most recent bear markets:
January 11, 1973 to October 3, 1974 The article begins, “Not for many years
has a Christmas season begun with so
The causes of the economic fright many tidings of spreading discomfort and
experienced by Americans in the 1970s lack of joy about the U.S. economy.
include the Vietnam War, Watergate, an Already wracked by a devastating double-
oil embargo, a double digit digit inflation, the nation is now also
unemployment rate, and a 16.8% plunging deeper into a recession that
increase in the cost of living. Over the seems sure to be the longest and could
course of 23 months, the market lost be the most severe since World War II.”
45% of its value, and many investors
eventually turned to the safety of CDs Despite Time’s grim predictions,
and bonds. Such extreme conditions had economists now agree that December
not been experienced in the United 1974 actually marked a turning point in
States since the Great Depression. the U.S. market: the S&P 500 soared
37.2% and 23.9% in 1975 and 1976
A 1974 Time magazine cover stating respectively.
“Recession’s Greetings” reflected the fear
of the nation, and the cover story’s title August 26, 1987 to December 4, 1987
prophesied “Gloomy Holidays – and
This bear market was as extreme as it
Worse Ahead.”
was short. On a day known as Black
Monday, the crash of markets around the Overall, the 1980s ended with a
world on October 19, 1987 also sent the compound return of the S&P 500 of
Dow Jones Industrial Average 17.6%.
plummeting 22.61%, which is still the
largest one-day percentage decline in March 24, 2000 to October 19, 2002
history. (In contrast, the stock market
crash of 1929 included only a 12.82% While many people remember the crash
decline on its Black Monday.) As in 1974, of the stock market following the
the plummet of the Dow panicked many September 11 terrorist attacks, this multi-
investors who desperately looked for event decline actually began with the
financial safety elsewhere. earlier bursting of the technology bubble
in 2000. By October 2002, at the end of
Again, Time magazine provided another
an exhausting 28 month period, the S&P
cover story depicting Americans’ dismay.
500 had lost 49.2%, and a young
generation that had previously felt
indestructible suddenly felt very
vulnerable. The September 14, 2001
Time magazine cover depicts the World
Trade Center’s Twin Towers in the final
moments before their collapse.
One story presented an hour-by-hour

account of events, and another argued
that “the U.S. . . . could not go on forever
spending more than it would tax itself to
pay for, buying more overseas than it
could earn from foreign sales, and One of the many signs that our country
borrowing more abroad than it could had come to a complete halt was the
easily repay. There had to be a day of closure of the New York Stock Exchange
reckoning, and it could unhinge the for 4 days after the attacks. Once the
whole world economy.” The disapproval markets reopened, the Dow Jones
and pessimism of this seemingly Industrial fell more than 17% over the
timeless statement gave investors little course of a week.
hope for the immediate future. However,
almost half of the Black Monday losses In 2001, the United States and its
were recovered in the days following the economy was vulnerable to outside
sell-off, and less than 3 months later, the forces and to the loss of it’s strong
S&P 500 finished the year up 2.3%. technology sector because of the
exposure of hidden greed in corporate America. 2002

was defined as the year corporate titans WorldCom and
Enron collapsed and the year that $2 million birthday
parties funded by the corporate dollars of Tyco ended.
As dark as the outlook was following the collapse of the

technology bubble and the devastation of September 11,
the markets eventually recovered: the S&P 500
2431 Devine Street
appreciated 14.3% in value between early 2003 and late
Columbia, SC 29205
2007.
888.799.9203
Despite oil embargos, double-digit inflation, the burst of
the 1990s technology bubble, and September 11, the
the wealth management past 35 years have produced a whopping appreciation of
services offered by J.E. Wilson 3,725% in the S&P 500. Investors cannot invest directly
Advisors, please visit in the S&P 500, but if they could have invested $100,000
in the early 1970s, their investments would potentially
www.jewilson.com .
have appreciated to over $3.7 million during those 35
years, assuming that our hypothetical investor had not
fallen victim to the greed and emotionally-driven
behavior that plagues the average investor. Though a
natural response is to panic when facing a challenging
bear market, we are less likely to make faulty decisions if
we can keep such market fluctuations in perspective.
©Copyright 2010
This article is the fourth in a series of lessons about the
Please feel free to pass on this barriers investors face as they work to achieve financial
article for personal use. security. Previous articles introduced the series and
However, no part of this outlined the ways investors’ behavior impacts their
publication may be reproduced decisions. The next article will explore the psychological
or retransmitted for commercial tendencies of investors and the challenge of overcoming
such tendencies as we explore the emotional and
intellectual responses a number of investors experience
photocopying, recording or any as part of the investment process.
fees.
Next Issue: Our Money and Our Brains
Our Money and Our Brains
T
O FEEL EXCITED WHEN OUR PORTFOLIOS INCREASE in
value and to experience fear when they decrease in value is
perfectly normal and acceptable. However, these emotions
become problematic once we start making decisions based on
emotional entanglements that limit our psychology, shows that any thoughts or
ability to reason. To prevent ourselves decisions about financial profit use the
from making such decisions, we first have same part of our brains that is hardwired
to recognize our capacity to make poor to pursue pleasure. In contrast, the
financial decisions based on emotions in experience of financial loss is processed
order to then recognize the emotions that by the part of our brain that triggers a full
drive them. In response, we can then reaction to pain or danger and causes
take a more defensive stance that could fight or flight. Your brain is so sensitive in
potentially limit the risk of damaging our such situations that it even responds
long-term financial security. differently if you are planning for short-
term monetary rewards than if you are
First, identify the enemy. We are our own
planning for long-term ones (Technology
worst enemies when it comes to
Review, May 2005, Huang). In other
managing our finances. When we
words, your responses to investment
understand how we tend to respond in
plans and outcomes are very complex.
certain circumstances, we can develop a
plan to defend our finances from our
Once you recognize these responses in
emotional responses the next time we
your own behavior patterns, you will have
have similar experiences.
a better chance of achieving financial
Second, recognize the challenges. You security. Recognizing them will also help
are likely very familiar with the excitement you keep your emotions in check the next
of financial gain and the fear of financial time we face a bear market, which is a
loss; however, you probably are not part of every five year cycle. Jason Zweig,
aware of how your brain’s wiring a columnist for the Wall Street Journal
influences those responses. Investing and editor of the revised edition of
affects us not only emotionally and Benjamin Graham’s The Intelligent
psychologically but physiologically as well. Investor (2003), expands on this mental
Neuroeconomics, the study of response with an analogy: “There is not
neuroscience, economics, and much difference in the brain between
having a rattlesnake slither across your sell too quickly because they want to do
living room carpet and having some stock so before the stocks start to lose value –
you own go down by 40% or 50%.” they hope to “quit while they are ahead.”
Recognizing that you may not have much If you tend to worry that you will regret
of a chance battling a rattlesnake similar investment decisions, listen to
barehanded, you might resort to a flight Deena Katz, a chairman for Evensky and
response because you merely hope to get Katz Wealth Management: “My mom
out alive. Not surprisingly, you may feel always said, if you’re going to do it, don’t
similarly in response to a disastrous drop worry; if you’re going to worry, don’t do
in the value of your investments. it. You’ve already made the commitment
to be where you are invested . . . You’re
Additional psychological forces include there. And unless you need to get out,
personal biases, emotions, and past you’re committed” (Money, May 2008).
experiences, all of which can influence
even experienced investors. Some Myopic Risk Aversion
psychological forces are quite obvious
Myopic risk aversion certainly sounds like
while others are very subtle.
something you would hear in an eye
Nevertheless, there are psychological
doctor’s office, and it actually does relate
pitfalls you can be aware of and
to a type of “vision.” People exhibiting
straightforward advice you can use to
myopic risk aversion cannot focus on
help mitigate their impact. A few of these
long-term gains because they are too
include a fear of regret, myopic risk
fixated on short-term losses. Such a
aversion, overconfidence, and the “herd
focus makes sense psychologically, but it
mentality.”
could be an exceptionally dangerous
Fear of Regret pitfall for investors right now. Even those
who are usually confident about their
Investors who are affected by fears of
long-term investment goals may become
regret put off financial decisions because
anxious about recent fluctuations in the
they hope to get even more information
market and might end up losing money
and feel even more confident before
unnecessarily because they can only
having to make decisions. Consequently,
focus nearsightedly on the immediate
these investors sometimes hold on to
future. To avoid this pitfall Robert Arnott,
losing stocks for too long or sell winning
the founder and chairman of Research
stocks too quickly. They hold on to losing
Affiliates (a developer of investment
stocks rather than accept a loss for two
products) suggests that rather than ask
reasons: they hope the investments will
yourself what you can do to make money
eventually make gains, and they feel as
in the next three months you should ask
though selling them confirms that they
yourself, “What would I want my portfolio
had made a mistake by buying them in
to look like over the next 30 years?”
the first place. Those with winning stocks
(Money, May 2008).
Overconfidence investors’ personal and financial goals

and even if doing so goes against their
Overconfidence is somewhat the
individual reasoning abilities. The Madoff
opposite of myopic risk aversion. Recent
Scandal illustrates this tendency perfectly.
research indicates that many investors,
Many people, who had long been
especially men, overestimate their own
successful investors, forgot about the
abilities as well as the accuracy of the
importance of research, prudence, and
information they gather prior to making
diversification in large part because they
financial decisions. As a result,
followed peers who were investing with
overconfident investors tend to overtrade,
Bernard Madoff. Recognizing the role
which usually leads to lower returns. An
societal influences played, David Zarolli
article in the February 2007 issue of Inc.
reported in a December 2008 story for
explains that “overconfidence is one of
NPR’s “All Things Considered” that “it
the worst failings an investor can have.”
was prestigious to invest with him.” In
Despite the temptation to guess the
fact, people even joined his country club
future or try to control what will happen
in Florida merely to meet him and get a
(both of which are forms of
personal invitation to invest with him. In
overconfidence), investors have to admit
addition to a prestige factor, behavioral
that neither is possible to do, no matter
finance experts explore other key reasons
how confident they may feel in their
we are willing to follow the herd. The
abilities.
Market Analysis, Research, and Education
Herd Mentality group, a unit of Fidelity Management’s
research company, explains that an
As Niccolo Machiavelli explained, “investor may follow the herd because he
“[People] nearly always follow the tracks or she feels an intuitive sense of
made by others.” Such behavior causes conformity, whereby aligning oneself with
us to go along with the collective wisdom the consensus of a large group going in
and tastes of the larger masses in a the same direction is more comfortable
variety of situations. Clothing fashions, than making an alternative, less-popular
community circles, automobile selection, choice.” If we follow the direction of a
and even investing habits reflect that larger group of investors, we can act
humans are social creatures who are very based on the assumption that many
likely to “follow the herd.” When it others must have access to superior
comes to investing, social environments knowledge. And how could so many
and the media heavily influence people others be wrong? Conversely, we tend to
into jumping blindly on the investment believe that the groups that we are part
bandwagon without employing sound of are naturally more likely to be right.
reasoning and research. Therefore, (Otherwise, we would not experience the
unfortunately, investors will unwittingly sense of affinity that defines those groups
follow the herd even if the herd’s to begin with.)
direction is to the detriment of the
Including the original Ponzi Scheme, can put your company online in three
there are quite a few historical examples months?” If only people had listened
when a number of individuals have fallen more to Warren Buffet and less to the
prey to the herd mentality. One, Tulip media’s promotion of the New Economy.
Mania, caused wealthy Dutch investors to
spend obscene amounts of money on One way to better appreciate the
tulip bulbs or on shares of bulbs. Some investment trend in the late 1990s is to
even went so far as to trade houses so study the relationship between net sales
they could invest in one or two tulip of equity mutual funds. During the first
bulbs! Such examples are evidence of quarter of 2000, as seen at Point 1 in the
the irrational behavior humans are graph on the next page, the stock market
capable of exhibiting, and we seem to be was coming off of five straight years of
especially vulnerable when we are double digit gains, and many of those
following others. gains were led by technology stocks.
Between 1995 and 1999, the S&P 500
An investment trend in the late 1990s
advanced 251% while the tech-heavy
also demonstrates a similar but
Nasdaq advanced 457%. In January
complicated example of herd mentality.
2000, at the peak of this multi-year rally,
During the emergence of the “New
a record number of media headlines
Economy,” Warren Buffet was ridiculed
alluded to a “bull market.” Then, as it
for his arcane investment theory because
turned out, the first quarter of 2000
others believed that the New Economy
ended up being the peak of the market:
marked a period when globalization and
over the next three years, the Nasdaq
the acceleration of developments in
plummeted 67%, which meant
information technology began to change
devastating losses for those investors who
economic trends. The mainstream media
had concentrated heavily on technology
extolled the possibilities offered by this
stocks. Those who had followed the herd
New Economy. As early as June 27,
and entered the market during the later
1994, John Huey of Fortune wrote, “The
stretches of the metaphorical stampede
advent of the new economy is
likely suffered the greatest losses because
unequivocably [sic] good news for the
they had joined the herd at the riskiest
U.S., which holds a wide lead over the
time.
rest of the world in developing, applying –
and now exporting – technology.” When Joining the herd as it ventures into new
referring to the New Economy, a territory and takes new risks can be just
September 27, 1999 Time magazine as costly as joining it too late because
article titled “Get Rich.com” asked, “If those who follow the herd to supposed
you're an entrepreneur, why waste your safety allow themselves to be led out of
time in the old world, worrying about the stock market at the wrong times, too.
manufacturing things and dealing with In the final quarter of 2002, for example,
unions and OSHA inspections, when you after nearly three consecutive calendar
years of downturns in the stock market, some investors did act individually and
the number of headlines that suggested may not have focused only on long-term
the possibility of a continuing bear market investments. Regardless, both types of
rose significantly. In response, investors investors lost money because of poor
became increasingly fearful and anxious decisions and bad timing.
before finally reaching the point of
Just as these investors retreated from
capitulation. Between June and October
equities during the second half of 2002,
2002 (Point 2), the S&P 500 declined
many also shifted their money into
16% and the Nasdaq declined 18% – in
money market funds because of their
just five months. Investors pulled a
relative safety. In November 2002, a
monthly average of 13 billion out of
record of 136 billion in net sales flowed
equity mutual funds compared to the
into these money market funds
average monthly inflow of 19 billion that
suggesting that many investors were
had continued during the previous five
turning away from stocks near the bottom
months.
of a three-year bear market. In fact, by
As the graph below shows, people were the end of 2002, the level of ownership
buying when it would have been a better in money market funds reached an all-
time to sell (Points 1 and 3) and were time high of nearly 35% of all
selling when it would have been better to outstanding United States mutual fund
buy (Point 2). It is worth noting that assets. At roughly the same time, the S&P
500 began a sharp comeback: it rose 29% in 2003,

which helped jumpstart a five-year bull market rally. For
those who had recently decided to follow the herd by
concentrating their portfolios into cash-like investments,
the move may have been very costly.
If you have ever been misguided because you followed

2431 Devine Street the herd, do not be too hard on yourself. Stephen
Columbia, SC 29205 Greenspan, the author of the book Annals of Gullibility,
888.799.9203 accounted in a recent Wall Street Journal article how
even he, someone knowledgeable about what can
For the complete article series happen as a result of trust and/or ignorance, lost some
of the savings he had accumulated from his book sales
to Bernard Madoff. Greenspan explains in the article
Advisors, please visit how “some risks are more hidden and, thus, trickier to
recognize than others” (2009). Investors of all
www.jewilson.com . experience levels need to always be cognizant of the
aspects of investing that influence their financial
decisions.
This article is the fifth in a series of lessons about the

barriers investors face as they work to achieve financial
security. Previous articles introduced the series, explored
©Copyright 2010 the importance of investor behavior in financial planning
All rights reserved. and provided an overview of the significant fluctuations
in the market over the last 35 years. The next article will
reinforce the importance and value of diversification.
publication may be reproduced by James E. Wilson, CFP
®

fees.
Next Issue: Diversification
Diversification
M
OST PEOPLE UNDERSTAND THE BASIC CONCEPT
behind diversification: do not put all of your eggs into
one basket. However, even people who are
sophisticated investors can fall into investment traps. For
example, many people have suffered of these investors have felt the pain of
losses because they placed a large such imprudent investment practices.
percentage of their investment capital in
In much the same way, other investors
their employers’ stock only to lose much
believe they have diversified their
of it during the recent downturn. Even
portfolios effectively because they own a
though the employees may have
number of different stocks. What they
understood that they were taking too
may not realize, however, is that they are
much of a risk in doing so, they did not
in for an emotional rollercoaster ride if
do anything to change their situations.
these investments all belong to the same
Instead, they justified holding the position
industry group or asset class and
they had established because of the large
therefore share similar risk factors. For
capital gains tax they would have to pay
instance, investors in the late 1990s and
upon selling the stock, or they imagined
early years of this decade learned that
that the stock was just on the verge of
diversification among a variety of high
taking off. In such instances, investors are
tech stock companies was really not
too close to a particular stock, and they
diversification at all. When a number of
develop a false sense of comfort and
prominent technology stocks, including
overconfidence. They may rationalize that
Cisco, Dell, and IBM, experienced billion
everyone with whom they work has
dollar sell-offs between Friday, March 10
invested in the company, and how could
and Monday, March 13, 2000, the
so many people be wrong? Similarly,
resulting chain reaction hit the entire tech
they rationalize the importance of their
industry.
investment in the company’s stock
because they are professionally invested Included with this article are charts that
in the company and feel a certain sense will help investors understand how
of loyalty. Over the past year alone, many diversification dramatically impacts a
portfolio. (It is important to remember, however, that

one cannot directly invest in the S&P 500. This chart
uses it as an index for illustration purposes only). So,
imagine someone whose hypothetical portfolio consisted
of a 100% investment in the S&P 500 (Portfolio 1).
Between 1998 and 2007, he would have achieved a
4.38% annualized compound return and for every $1.00
2431 Devine Street invested, he would have ended up with $1.47. However,
Columbia, SC 29205 if he had merely invested 40% in a 2-Year Global Fixed
888.799.9203 Income Fund with the remaining 60% still in the S&P
500 (Portfolio 2), his annualized compound return
For the complete article series increases to 4.72% and each dollar is now worth $1.51.
Portfolio 5 shows additional diversification including
investments in U.S. small and large value companies as
Advisors, please visit well as in real estate. The annualized compound return
of Portfolio 5 jumps to 8.9% while the growth of $1
www.jewilson.com . reaches $2.15. Adding international stocks to Portfolio
10 even better demonstrates the potential of
diversification because it achieves more than double the
annualized compound return of Portfolio 1 (10.08%),
and our investor’s $1 has now reached a value of $2.37.
Explained this way, the benefits of diversifying are
obvious; however, many people fail to take advantage of
©Copyright 2010
the potential of diversification.
®
fees. Next Issue: Hard and Fast Solutions
Hard and Fast Solutions
W
E WILL DISCUSS SOLUTIONS MORE EXTENSIVELY in a
future volume of articles, but they are worth
summarizing here as well.
Investor Behavior & the Buy-Sell Cycle: Whether trying to focus on the immediate
Investors frequently engage in a buy-sell future or trying to plan for retirement,
cycle that can be destructive to their investors who utilize cash flow models
portfolios as long as they are not aware of can avoid making rash, costly mistakes.
their behavior or able to modify it. Quite An informed investment advisor, and
simply, this cycle begins with the even online tools, can help you develop
purchase of stock that an investor an accurate cash flow model.
believes will be particularly lucrative.
Managing Investment Costs: A valued
Greed kicks in and all is well until the
advisor can manage clients’ investments
stock begins to lose value. As soon as
objectively and can assist clients in
this happens, the investor experiences
making research-based decisions, which
fear, regret, and, eventually, panic if the
is important since investors can only
stock’s value continues to decline. The
control those factors of which they are
investor sells the stock just before new
aware. Similarly, such an advisor can also
information comes out that will send its
help clients limit the cost of investing,
value soaring. Recognizing and
which in turn increases the amount of the
understanding this potential behavior will
investment return that clients keep in
help investors avoid it.
their pockets.
Managing Risk and Reducing Volatility:

Investors will manage risk and reduce
volatility more effectively if they have an
efficiently designed portfolio. For every
level of risk, the portfolio should take into
account the optimal combination of
investments that will give the highest rate
of return.
To do so, investors can utilize a variety of

Cash Flow Models: As investors assess
resources to stay informed and may also
where they are financially and where they
benefit from working with a valued
would like to be, they will find cash flow
advisor.
models to be incredibly helpful tools.
Conclusion: Now that you have some historical context,

consider where we are today. During the first quarter of
2009, investors moved 285 billion in new net capital into
money market funds and withdrew a net 31 billion out
of equity funds. Do these changes suggest herd
behavior? Perhaps. However, what long-term investors
need to recognize is that if they radically alter their well-
2431 Devine Street diversified portfolios, they also need to be prepared to
Columbia, SC 29205 assume a higher tolerance for risk. For example,
888.799.9203 investors who may have significantly lightened their
exposure to risk by selling stocks in late 2008 and early
For the complete article series 2009 might not have moved back into the market to
or for more information about participate in the 38% rally that took place between mid-
the wealth management March and mid-June of 2009. (On March 9, the S&P 500
was at 676.53, and by June 8 it was up to 939.14.)
Though it begins to sound like a broken record,
www.jewilson.com . maintaining a diversified portfolio with exposure to
multiple asset classes throughout a variety of market
cycles really is the strategy that has provided investors
with the least volatility in their returns. And these returns
also end up being the most consistent with investors’
expectations.
©Copyright 2010 Investors face a number of challenges if they plan to

All rights reserved. have successful investment experiences over the years.
Of primary concern are the psychological impediments
Please feel free to pass on this that make it difficult for us to make good decisions
consistently. Investors also face the certainty of market
volatility, as evidenced by historical trends. Therefore,
or retransmitted for commercial they should utilize the resources necessary to manage
use in any form or by any means, investment costs and to process current academic
including, but not limited to, research on corporate stock pricing, portfolio
electronic, mechanical, construction and management.
Additionally, take the time to remember the impact your
permission of the authors. emotions can have on your decision-making abilities
Unauthorized copying may when you are making financial decisions. Consider
subject violators to criminal carefully not only the decisions you are facing, but also
penalties as well as liabilities for why you are contemplating them in the first place. Just
substantial monetary damages up being aware of the emotional complexities of making
financial decisions will help you achieve financial
security.
fees. ®

JEW Whitepaper 2010

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BARRIERS TO FINANCIAL SECURITY: IMPORTANT LESSONS Vol.

Amazon.com, once merely a retail book Recession Starts Taking a Toll:

Investor behavior does matter, and it arguably poses the

booming, so few people were likely to Running Short of Cash

These were not pulled from today’s headlines. They

Please feel free to pass on this

Why is Investor Behavior So Important?

P ERHAPS THE MOST IMPORTANT INGREDIENTS TO long-

Source: “Qualitative Analysis of Investor Behavior,” DALBAR, Inc, 2008

This is a loss of 69% of the available return of $806,231.

Unfortunately, most investors fall prey to a thought

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Your Portfolio’s Worst Enemy

Investors should understand how their own behavior

This article is the third in a series about the barriers

2431 Devine Street by James E. Wilson, CFP

For the complete article series

Please feel free to pass on this

To better understand these patterns from

One story presented an hour-by-hour

exposure of hidden greed in corporate America. 2002

As dark as the outlook was following the collapse of the

Our Money and Our Brains

value and to experience fear when they decrease in value is

perfectly normal and acceptable. However, these emotions

become problematic once we start making decisions based on

Overconfidence investors’ personal and financial goals

500 began a sharp comeback: it rose 29% in 2003,

If you have ever been misguided because you followed

This article is the fifth in a series of lessons about the

or retransmitted for commercial

portfolio. (It is important to remember, however, that

Hard and Fast Solutions

Managing Risk and Reducing Volatility:

To do so, investors can utilize a variety of

Conclusion: Now that you have some historical context,

©Copyright 2010 Investors face a number of challenges if they plan to

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