Big Changes in the Financial World
The financial world changed in a big way on May 1, 1975. On that day, fixed sales commissions on individual stock trades ceased to exist. Trading commissions became negotiable between the customer and the broker. Almost immediately, discount stock brokerage firms appeared offering investors the ability to direct their own investing in return for discounted commissions on trades. All was good…or so we thought.
Around the same time, (1974 to be exact), index mutual funds came to the market as well as hundreds—which morphed quickly into thousands—of actively-managed mutual funds (i.e. funds trying to beat the index). Whole departments were created in big brokerage firms to “manufacture” new investments. Most of these investments were complex and designed to take advantage of some particular hot-button aspect of the existing tax or economic structure. These products also served the purpose of rebuilding the revenue stream of the brokers who suffered after the era of fixed brokerage commissions ended. These products were mostly sold to investors who were trying to manage their financial lives on their own. Do-it-yourself investing was fully in vogue.
For the overwhelming majority, however, the promise of do-it-yourself investing has largely failed. Four decades of experience now show us that investors require objective guidance in order to navigate the choppy waters of the financial and investing world. The complexity of the investment markets in 1975 pales in comparison to the complications across the board in today’s markets. Far from the simplicity of trading an individual stock with a negotiated commission rate, thousands of complex, multi-layered investments compete for attention today. It is nearly impossible for even a well-informed investor to attain any meaningful level of mastery.
Choices in the “Run-Up” and “Wind-Up” Phases
Of course, investing is but one aspect of financial life. Implementing financial planning techniques and methods often requires significant technical expertise. The most challenging area of all for investors to handle is the emotional component. Behavioral biases and blind spots can easily unravel even the best plans. Those in the “Run-Up” and “Wind-Up” phases of their financial lives, (otherwise known as those in their 50’s and 60’s), face tough emotional questions that simply can’t be answered by computers.
Most of the foundational research in behavioral finance has taken place over the past 25 years or so. As a result, we understand much more clearly today the impact of cognitive errors on financial choices. While it may be impossible to completely overcome behavioral biases, it is possible to control what you do after the initial reaction.
Different Generations: Different Learning Styles
The manner by which investors learn varies dramatically from one generation to the next. We are still in the timeframe where those in the middle of the baby boom generation are reaching normal (or average) retirement age. About 10,000 boomers reach age 65 each day, and this pattern will continue for about 10 more years. Boomers have come late to the investing world and mostly learn by doing. This can be problematic since individual “bad” decisions can end up with “good” results. For instance, someone invests all their assets in a single risky stock that eventually pays off. The feedback from this isolated transaction can encourage more “bad” behavior. Instead, it is wiser to look at the entirety of possible results, not just the “good” result that happened one time.
Generation X, otherwise known as those born between the early 1960’s and the late 1970’s, seem to rely heavily on their peers for information. There is some evidence that those in this generation have taken note of self-inflicted problems of many boomers and generally don’t approach investing in the same way.
While there are still many rugged individualists among us, relatively few are successful at what matters most. However, the idea of being able to do everything on your own remains attractive, despite the poor track record. There will always be those who insist on making financial decisions without specific guidance. Our focus is on those who have concluded—even if begrudgingly—that they require help. Ready to make some changes? Ready for a real conversation?