Discipline is an investor’s greatest tool

The most sucessful clients are not market-dependent

There are many reasons the Federal Reserve has yet to reverse its course on historically low interest rates. The most obvious reason is also the most surprising: inflation, or the lack thereof.

In the past decade, we have experienced three significant deflation-inducing economic phases. First, there was the broad and global economic collapse of 2008-09, courtesy of the credit and housing bubble. Second, the eurozone crisis of 2011, and last, the recent market correction facilitated by an ongoing decline in commodity prices and a slowdown by our friends in China.

According to the Bureau of Labor Statistics, the past decade has seen a remarkable downward inflationary shift. From 2005 through August 2015, the inflation rate ranged from 3.4 percent to 0.1 percent (2009) with 2007 topping out at 4.1 percent (remember that housing bubble?).

This is historic. While it means the prices of some commodities and durable goods have remained steady, it also reflects an economy with flatter wages despite increased productivity. While out-of-control inflation generates economic upheavals and stark headlines as it did in the 1970s, deflation has its own set of circumstances – including a dampening impact on long-term investment returns.

The point here is not to focus on inflation, but to realize that what happened on the inflation front is extraordinary and unprecedented. Few could have factored this development in their long-term retirement investment goals, particularly since humans like to extrapolate the past – also known as “recency bias.”

This brings us to the issue of “sequence risk,” which reminds us that in some matters, timing can be everything. In a world that has shifted from the standard defined benefit (i.e. your grandparent’s pension plan) to defined contribution (i.e. IRAs and 401k plans), this awareness of what we can and can’t control should be significant.

The shift to more personal responsibility for funding our financial security has been dramatic in the past four decades. This transferal in liability has occurred simultaneously with a decline in real returns in many asset classes.

Using computer algorithms that didn’t exist 10 to 15 years ago, financial researchers are better able to understand why two workers with similar salaries, the same number of years worked until retirement, and the same market investment return rates could potentially have vastly different final cash returns.

In a recent white paper on sequence risk, Peter Chiappinelli and Ram Thirukkonda, analysts from the advising firm GMO, offered this scenario:

“Even if an individual employee does everything ‘right’ – participates in the (defined contribution) plan, defers income religiously, takes full advantage of the company match, and even gets his exact expected return from his investments – he can still fall victim to disappointing final wealth outcomes if the order of those returns works against him.”

In the GMO scenario titled, “Who Ate Joe’s Retirement Money?”, the final portfolio difference of around $300,000 between Joe and Jane was timing: Jane was in the accumulation phase during a phase of stock market appreciation while Joe missed a good part of that era because he started work more than a decade earlier (1954) than Jane (1967).

In Joe’s example, timing was everything as he became subjected to a period of lower returns while his asset base was significant as he entered the distribution phase for his nest egg.

We don’t control when investors were born, began to save, or if they delay savings due to a divorce or a period of conspicuous consumption. Personal and professional decisions, not market results, can impact the variability of outcomes. Advisors and their investors should not depend on alchemy to provide financial security. That was Mr. Madoff’s role, and we all know how that ended.

We have found that our most successful clients are not market-dependent.

In addition to a disciplined and diverse mix of investments, successful clients focus their behavior on what they can control:

 • Their spending and savings habits

 • The sequence of behavior and decisions

 • Utilizing proper tax and asset allocation

 • Keeping an even emotional keel about day-to-day market fluctuations: They don’t give in to “recency bias” and avoid extrapolating past returns (whether generous or subpar) into the future

Fate is often unkind, but our greatest tool in overcoming destiny is making a simple and disciplined plan, reviewing that plan regularly, and adjusting to circumstances and life events. Though we can’t change our birth order or many elements of our essence, we do have the ability to create outcomes more like Jane’s than Joe’s.

Tom Sedoric, a nationally recognized wealth manager, is managing director-investments at The Sedoric Group of Wells Fargo Advisors in Portsmouth, 603-430-8000 and thesedoricgroup.com.