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November 30, 2016

Exploring Optics and Anchoring

Larry has been using some version of the chart below for more than 25 years when talking with clients about what he calls “optics.” The idea is that the way an investor sees the market is different depending on when they retire or open an account. Markets move up and down over time, but they slowly trend higher. This chart is a simplified picture of stocks over time.

Imagine two investors who have both been working and saving their entire careers. Anne retires at point A and one year later Barry retires at point B. Another year later the market is at point C, but Anne and Barry have had very different experiences as investors since retiring.

Barry feels great about his decision to retire. His investments are likely earning more money than he is taking out (he may be considering taking out some extra money to go on a trip) and his investment manager has been doing a much better job than his old 401(k).

Anne feels differently. Although the market is above where it was when she retired, she may have been taking money out and her accounts might not have fully recovered. She may question the advice she has received and worry that her money is not going to last.

These differences may even be true if both Anne and Barry have the exact same amount of money at point C. They could be withdrawing the same amount from their investments and have the same exact investment approach. They see things differently because they measure from a different point in time. My father would say we aren’t as smart as Barry thinks we are nor are we as dumb as Anne might think we are as advisors.

Academics call this anchoring. We pick a value or point in time to measure from and we anchor to that point. It’s perfectly normal and virtually everyone does it. However, if Anne and Barry are in the same situation at point C, shouldn’t they make similar decisions? That’s the danger of anchoring because your decisions will be driven not by your current situation, but by looking backwards at where you were at other specific points in time. The market doesn’t know the difference between Anne and Barry and it isn’t out to get anyone no matter how it may appear.

The worst point to anchor (and the most common) is when investors compare everything to the highest balance they’ve ever had. Even during up markets you will spend two thirds of your time disappointed.

Bottom Line: Perspective matters! It’s more about where you are today than where you were in the past.

From the desk of Kris Carroll

Market Volatility, Retirement Income, Risk

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