In a financial plan the “What do I want?” “When do I want it?” and “Who will participate?” questions tend to be easy to work through. Even for the people who are in the do it yourself mode.
Those same people tend to have problems with the “What if ____?” questions. They are seldom all covered off because most of them are unpleasant. What if I die? What if I get sick and cannot work? What if I lose my job? What if someone in the family has problems? What if the market drops 50%?
“What if?” is the risk question. Failing to notice them enhances them.
There are two general forms of risk.
Catastrophic ones like death, disability, house fire, automotive liability and some others. These risks tend to be on or off. They happened or they did not. In most cases the costs are very high. Beyond the capacity of a person to absorb without changing their lifestyle. Most are improbable and therefore it is reasonable to insure them. It is just arithmetic to calculate the potential loss and then arrange appropriate coverage. I suppose the do-it-yourself folks may need some help surveying the market for the proper insurance.
Investment risk, or variability, is another kind of problem. Is it risky if the market goes up and down in the short run, but over a long time tends to be up about 10% before fees?
Answer – YES!
The risk is not really market risk. It is the risk of human error. Markets fluctuate and everyone knows that. If people wait, the markets usually recover. But, people don’t make decisions based on the long run, even though they sometimes think that they do. People are emotional and impatient. They do what is expedient or what makes them feel better. As one of my computer industry friends says, “Liveware is the real defect.”
People feel badly when the market value of their holdings fall, even if only on paper. They make decisions, at least partly, in response to how they feel. Making decisions when your negative feelings are dominant usually loses. Change tends to be negative in the short run so a downward spiral may develop.
When advising, recall an important rule of emotional connectedness. “There is such a thing as a paper profit, but all losses are real.” People attach to gains intellectually, but they attach to losses viscerally.
I have no problem with people wanting to manage their own affairs. I think that it would be wise for them to know what the range of duties are before deciding they can do it all by themselves. Many find too late that there were important elements that they missed or that they were incompetent implementing. A key duty often overlooked is managing fear and greed.
Be sure to review the “What if?” questions in some detail and work out a response to them ahead of time. That is what preparedness is about.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.