Developing Behavioral Resilience In Investing

by | Jul 11, 2018

 

 

SEE FULL VIDEO TRANSCRIPT BELOW:

– What’s up everybody. It’s Justin Harvey here at Quantifi Planning. Hope you’re doing well. I wanted to film a quick video to help my physician clients invest more effectively by establishing behavioral resilience. And this is the way I wanna do that.

I wanna bring to your attention what is what I believe one of the key statistical relationships that exists in financial markets. We are going to use this statistical relationship to build, in five minutes or less, an investment system that is going to help you as an investor have behavioral resilience. It’s gonna keep you from making the wrong decision at the wrong time with regards to your financial affairs and costing yourself a lot of money.

The statistical relationship I wanna bring to your attention, and shout out to Ben Carlson, one of my favorite financial bloggers, for bringing this to my attention has to do with S and P returns over the rolling periods from the 20s up until this date, it was last updated in 2015 where I found it.

As the time frame extends, going from daily to quarterly all the way down to 20 years, the occurrence of a positive outcome of having a positive investment return approaches 100% in historical terms. What this means is the longer you’re invested in equities the more and more likely that the outcome you’re gonna experience is gonna be positive. This is something we can use, it’s a very powerful principle we can use in order to manage our own affairs to create a system that’s going to optimize our investments and help us to not make bad decisions.

How is that going to work, you ask? We’re going to use this principle, time segmentation to take advantage of these return streams so that we experience more of this, positive outcomes, over long periods of time and we limit the risk that we have in shorter periods. Now, this method that I’m gonna share with you is far from rocket science, actually it’s quite simple.  There’s a certain elegance to it’s simplicity and if you implement it, it can have significant behavioral benefits which I’ll share. So, this is going to be a review for many of my financial friends. What I’m going to propose to you today is what is commonly known as the bucket strategy. So we have three buckets and they are segmented based on time period.

So bucket number one, this is your short-term bucket, you know, six to 12 to 18 months, things that you’re gonna need in the interim, checking, savings accounts. We’re going to take zero market risk here. These are going to be FDIC insured accounts up to 250K at a Credit Union or at your bank. This is going to be cash and cash equivalents. This is going to be money that you will need pretty soon and so we wanna make sure that there’s no risk involved. That’s bucket number one, and this is the short-term time segment.

Bucket number two we’re gonna divide out as to, you know, your intermediate-term goals. This is like five to seven years and shorter. And what we’re doing here is we’re taking a very conservative position, a lot of cash, short-term bonds that are low duration and low risk and we’re taking a tiny, tiny bit of market risk. What we’re trying to do is earn a little bit of interest on this in some cases but essentially capital preservation is the main goal of bucket number two.

And segment number three, long-term. This is seven to 10 years and out. This is going to be an equity focused strategy. This is where we’re going to take our market risk. Now why is it that this time segmentation strategy is going to allow us to have behavioral resilience? Well it has to do with these market return streams. So look at this, you know, daily return, it’s a flip of a coin whether or not I’m going to make money tomorrow in the stock market.

But, the longer our time frame gets the more reliable it is that equities are going to deliver a positive return for me. So the way that we build this system is to take these time periods, when it’s, you know, shorter term, when the outcomes are less certain and these time periods are going to correspond with taking no market risk and taking very small market risk for these time frames inside five to seven years. And then once we get up to time periods where 10 and 20 years, the outcomes are much more certain, that’s where we’re taking equity risks, right. That’s where we’re going to be more aggressively invested for retirement or, you know, IRA, 401K, things that you’re not going to need for a long time.

And what that does is that serves to give us this mental system where we can have an understanding of the way we’re invested and how whenever CNN tells you, oh my gosh the Dow’s down 1,700 points and you need to be freaking out about it, we know that the place we’re taking equity risk is in bucket number three.  e don’t need it for seven to 10 years or more and there’s absolutely zero reason for us to be freaked out because buckets number one and two, you know, this is what we need in the short-term, right, there’s no equity risk here.

There’s no headline that’s gonna impact what’s happening in buckets one and two and therefore we can be free. We don’t need to be anxious, we don’t need to be worried. We’ve used this time segmentation method based on a statistical relationship in the stock market to be able to optimize our returns and optimize outcomes and help us in the process manage our own behavior. So we’re not gonna hit the eject button at exactly the wrong time and cost ourselves, potentially do irreparable damage to our retirement plan.

That’s all I’ve got for today. If you have any questions definitely feel free to leave a comment below. Hope everybody has a great day. Thanks for taking the time to watch this video.

 

Disclaimer

Herein contains my one-take thoughts on financial concepts, behavioral investing, money management strategies, financial media, and letting you “behind the curtain” on my efforts to help move my physician clients toward financial independence.  Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Website Disclaimer page for a full disclaimer.

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