Hedonists and Risk re-raters

People are scared by the tumbling markets and in some cases, they should be. They made decisions over the past three or four years that have made them less equipped to deal with the current market and economic situation. In fact, I can actually pinpoint those who are in full freak-out mode while the majority of others are clearly concerned, but not spinning out of control and making rash decisions.

The two categories of people that seem to be in full-fledged hysteria are: the hedonists and the risk re-raters. Let’s start with the former. Over the course of the past decade or so, hedonism had made a revival in America. There was the hyper-focus on living it up, enjoying the best there is and even a resort called “Hedonism.” The good times were fueled by two asset bubbles -- the stock and housing markets -- and were super-charged by ultra-low interest rates.

The hedonists lived beyond their means—they chose to purchase homes that were too expensive; went out to dinner, bought fancy cars and vacationed instead of saving more in their retirement accounts; decided to retire too early; and simply spent too much money. I spoke to a couple who never would have considered themselves as hedonists, but indeed they are. Three years ago, they started to talk about their longer term goals. They planned to work for 5-10 years, leave the Northeast and relocate down south.

But then the housing market exploded and all of their friends were buying land and condos and they wanted in on the action. They called me after they had placed a $70,000 down payment on a piece of land and informed me that they intended to rent out the place down south until they were ready to retire. Flash forward to today and you know the story: the $600,000 house is almost complete, nobody is interested in renting and they are now carrying two homes with two mortgages and are that much closer to retirement. Is it any surprise that this couple is not sleeping as they watch their portfolio drop from $1,000,000 to $850,000? Believe me when I tell you that they do not want to hear that they are “only” down half the amount of the overall stock market. They are paying for their desires now and it hurts badly. Chances are hedonists would feel far better about the value of their investment accounts if they had not overextended themselves in the period prior to this one.

The “Risk re-raters” are a different genus. These are the investors who were happy to assume risk in their portfolios as long as the market was moving in the “right” direction. They tended to be among the more annoying clients in a rising market environment ---“Can’t we do better? I think we should own more (fill in the blank of the asset class that was up the most in the prior year) to improve our returns!” The dutiful advisor would talk about what happens when the market goes down, warning that while it is great to assume more risk when things are going well, it doesn’t feel so hot when the markets move in the opposite direction. This is usually met with a nodding head and then a rush to sign new paperwork and increase the risk levels.

As the down market turns into a raging bear market, these are among the first people we hear from—they are worried that their growth (what exactly did they think “growth” meant?) portfolios are down “so much.” Forget trying to explain that they are not down nearly as much as the market, or even to remind them that they had made this decision against all better judgment. These are among the first people who want OUT immediately and who say that they will get back in when “things settle down.”

This occurred with a client I will call “Jane,” who retired from working full time four years ago at the age of 58. At the time, she had a pile of money and I advised taking a less risky approach to her portfolio, because she could—meaning that because she had done the hard work of accumulating $4,000,000, she did not have to go beyond being a balanced investor over the next thirty years or so. After the first year, she came in for a meeting with one goal in mind: she wanted to earn more on her investment account so that she could stop working part-time. She recounted how friends of hers were doing much better with their money and that she wanted in on the action. She pushed all of the warnings aside, quit her job, increased the risk and then when the September massacre occurred, she pulled out of everything—completely!

The moral of this column is not to make people feel bad about losing money in the markets—we are all in the same boat on that front. Rather this is an important reminder that the decisions we make in our lives can often be the difference between being able to weather the storm and enjoying a good night sleep and succumbing to emotions and making another set of bad decisions. That is perhaps the silver lining for those of us in the advice-giving business…maybe this current cycle of lessons will finally help shift behavior in the future and prompt people to make more prudent financial decisions in our next phase.