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Saturday, March 5, 2016

Why Trading in Retirement Is a Bad Idea

By JOHN F. WASIK
MARCH 4, 2016

You have a significant retirement portfolio, it’s yours to manage and you have time on your hands. You’re a smart person and you’re sure you can beat the market — or at least do better than a boring basket of mutual funds and income investments.

That’s what Elmer Naples, 75, a former utility company engineer in Trenton, said he was thinking when he retired 20 years ago. Then the stock market started doing its trapeze act and he thought better of his plan and switched to a fee-only financial planner 10 years ago.

“I tried everything,” Mr. Naples recalled. “I owned stocks, mutual funds, C.D.s, bonds, diamonds and silver. I was handling all of our finances at first, then I got a little tired of the stock market. I wanted to put things on automatic.”

Like millions of retirees, Mr. Naples used his time to research investments that he hoped would preserve and increase his wealth. And like millions of others, he learned that it’s hard for an individual investor — even a retired one with lots of spare time — to outdo the pros and beat the market’s maddening volatility.

The Achilles’ heel for investors in retirement is a punishing stock market downturn that reduces not only their income stream but also their total wealth. Even the most astute individual investors have a hard time seeing bubbles inflating and knowing when to get out. They may even be part of the bubble inflation.

According to findings by the researchers Terrance Odean, Eduardo Andrade and Shengle Lin, investors naturally get excited by investing during bubbles and are often blinded by emotion. They may not understand how vulnerable they are when the bubble pops.

“Rapid, unexpected increases in wealth during the appreciation phase of asset pricing bubbles can lead investors to experience intense, positive emotions,” the researchers found. If they’re excited about, say, tech stocks, they buy more of them.

When markets turn sour, though, and professional investors are buying stocks whose prices have fallen, many individual investors retreat to the sidelines. For those in retirement, this is a sure way to underperform the market and often lose money. Because no one quite knows when it’s time to leave an inflated market or when to return and shop for bargains, millions of people guess wrong or follow the current trend. Market timing is a mug’s game.

Indeed, in the 2008-9 sell-off, willingness to take “above-average or substantial investment risk” fell to 19 percent in 2009 from 23 percent in mid-2008, according to the Investment Company Institute, a mutual fund trade group. The appetite for risk didn’t return to pre-crash levels until 2013 — and those who stayed out of the market missed most of the rebound in share prices of American stocks.

George A. Akerlof and Robert J. Shiller, Nobel laureates and the authors of “Phishing for Phools: The Economics of Manipulation and Deception,” call the siren call of Wall Street’s latest darlings “phishing.” That’s when a profit can be made off deception, enthusiasm, weakness and greed. Too many investors believe the narrative of the next best thing or easy money, derailing millions of retirement portfolios.

“It’s the world’s oldest story,” said Professor Akerlof, who is now at Georgetown University. “Someone’s always dangling an apple, and that snake decided to be there.”

When it comes to investing, he noted, people love stories. What company will make everyone’s life easier, connect the world and cure disease? “Stories get people to buy,” Professor Akerlof said. “But when the story goes viral — or becomes a New Yorker cartoon — it’s time to sell.”

How many retirees have the discipline to resist compelling narratives, especially when they have a lot of time to think about them? Not many, which builds a case for either studied self-discipline, such as a firm, long-term investment strategy, or employing an outside adviser.

In Mr. Naples’s case, after careful consideration he and his wife hired Len Hayduchok, a fee-based certified financial planner based in Hamilton, N.J., who set them up with a passively managed portfolio and counseled them on their financial and estate goals.

“For some folks, investing might be something they’re qualified to do,” Mr. Hayduchok said. “But many underestimate the expertise needed. The average investor gets returns that are half of the benchmark.”

At the very least, a qualified third party such as a financial planner or a registered investment adviser can take a lot of decisions off the table.

No longer will you have to worry about whether you are buying into a bubble or need to know when to get out. The focus will be on your long-term goals and not short-term headlines or manias. Besides, you stand little chance of success in an age of high-frequency trading and mountains of real-time information being absorbed by big traders every second of the day.

“Most normal buyers should do buy-and-hold,” Professor Akerlof recommended. He said he invested his own retirement money in index mutual funds.

“Adopt a strategy that’s ‘phool-proof’ and go for long-term investing,” he suggested. That means holding wide swaths of global stocks, bonds and real estate through mutual and exchange-traded funds sold by BlackRock (iShares), Dimensional Fund Advisors, Fidelity Investments, State Street Global Advisors (SPDRs), Charles Schwab and the Vanguard Group.

Still, investors might keep their hands in managing if they trade with no more than 10 percent of their portfolio. You may be able to insulate yourself by buying stocks with solid dividends and reinvesting the quarterly payments in new shares commission-free, through dividend reinvestment plans. You can often snag bargains when the market dips, as it did in the first weeks of this year.

For the bulk of your portfolio, how do you find a professional who will shield you from your worst instincts? Seek out a fiduciary — that is, someone legally obligated to put your best interests first. They should not receive a commission from selling you anything. They can charge by the hour, a flat fee or a percentage fee based on annual assets under management.

A financial planner, a chartered financial analyst or a personal financial adviser can draft and maintain a holistic financial plan that takes into account taxes, income,estate planning and other financial considerations. At the very minimum, a financial adviser who identifies, analyzes and respects your long-term goals — and keeps you on track — may be worth the investment.

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