Moneywise24 Personal Finance

Retirement planning seems to be a pretty hot topic, it is everywhere and people are discussing it intensely; in magazines, on blogs, and over a drink with friends. I agree, I want to maintain my living standard when I grow old myself, maintaining a degree of financial security. But I just can’t help having this creepy feeling, that in despite of all the saving, investing, and calculations, I have no clue what I am actually doing.

Retirement systems are different around the world. In Europe, where I live, retirement is usually built on three major pillars:

• Governmental retirement payments – an amount is subtracted along with taxes by the government. The money is used to support who are retired at this very moment. As time passes, I am collecting points, and when I retire I will be receiving a governmental retirement support, which is based on the average salary during my lifetime.
• Tax deductable retirement fund – This portion is subtracted from the gross pay, and it is directly invested in a retirement fund. Often, employers will fund a portion of the retirement fund.
• Privately organized funds, such as health insurances or individual investments, which are paid for after taxes have been deducted.

The importance of each pillar may be different in each counry in the European Union, my writing is primarily based on the German system.

The question is, where is this actually going? Each pillar has a number of variables, which need to be in order to ensure that the retirement planning actually works: Read the rest of this entry →

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Just a quick search via Google, and the term “double dip recession” returns 1.8 million results. The topic is hot, and many people, if not the majority, believe that a double dip recession is on its way. Many articles speak of fear of a double dip, and try to anticipate whether and when a double dip might hit us.

Although such discussions are highly interesting, I tend to focus more on how to handle such a recession for now; because if it hits us, there will be nothing we can do to stop it, no matter whether we fear it or not. The question I ask myself is how I handle it, and even more importantly what I can do to stay out of trouble when it hits.

My first concern is securing my income. I am not yet in a position in which I run my own company, or where I can live off my savings for years. So, having a job is important. Where I live, in Germany, it is very difficult to fire employees. However, if a recession hits, even those employees doing a good job may be fired if else the existence of the company is in danger. Since I am male, single, and have no children, I would the first person gone. I would receive 70% of my last salary for nearly a year, but what about after that?

I took an insurance a while ago, which aims specifically at unemployment through no fault of one’s own. This insurance ensures that I receive up to a specific amount. I have calculated my minimum living standards, and added a buffer, which is the minimum amount I need to live off. If for some reason my living expenses go up (e.g. I bought a car, or rent increased), I can adjust the insurance to a new payout level.

Secondly, I continuously keep increasing my cash assets. This is my emergency fund, which I can use for unexpected expenses, either in or outside a recession. Having cash readily available gives me a more secure feeling.

On the long run I am investing in mutual funds. The amount is still small, but as soon as I sell these shares I will need to pay taxes. Therefore, I tend to keep the funds in my portfolio, but I will stop investing more money into them until the recession is bottoming out. This allows me to not unnecessarily increase my losses. Additionally, I might buy put options on one or more indexes, as a form of insurance. As the mutual funds (or stocks) are losing value, the put options are gaining value and are balancing out the losses, either completely or partially. However, I will monitor economic developments closely, and not judge too soon. The technical analysis functions help me to make an estimation of whether we are simply having volatile markets, or whether a recession is in the making.

When it comes to stocks, I tend to follow cyclical movements. I am not a big fan of the notorious buy-and-hold strategy, since these strategies were largely developed in the last millennium, where markets were not as volatile as today, and steadily increasing. When I buy stocks, I will look at undervalued or high-potential companies, but I will consider their cyclical movements. This means that I will set a stop-loss at all times, and in the event of a recession the stock will be sold automatically. Following the recession movement, it allows me to re-enter the market at lower prices.

During a recession, my expense policy changes slightly. I watch more closely not to buy items I do not necessarily need, and I am very keen on building my cash emergency assets. I might use the car less and take public transportation, and use each and every opportunity to save a bit of money. Also, I find a recession a great opportunity to visit friends at their homes, or invite people over, and just stay home and have a fun evening.

Surely I hope the double dip will not come… but a next recession will come for sure. Just as a fact: by the end of 2012, another batch of mortgage contracts will phase out, and there is a real estate bubble in China in the making, which is 5 times as large as in the US in 2008/2009. This is another reason why I prefer to stay out of any mutual funds or stocks with a real estate focus.

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I have to admit, I don’t have the best ‘education’ when it comes to doing investments. I didn’t grow up in a family, that taught me all about finance, and even during my education International Business Management, investments and the stock market wasn’t dealt with in great detail.

I did my first investment in 1998… or rather speculation, when I bought an option in a company, which later appeared to have falsified its bookkeeping; and thus they went bankrupt. I didn’t touch investments for a few years. Then I learned a bit more about fundamental analysis, and I thought I got it… I learned about technical analysis, and I had thought I had understood it.

But it’s when I started reading about behavioral finance, that kind of opened my eyes. I realized that everything I had done wrong, and my losses were more the result of submitting to my emotions rather than bad analysis. I want to deal with three of these typical emotions, and how they can ruin virtually any potentially good investment.

Information Bias

One of the main problems, is that people are very subjective beings. I always found it strange that for some reason I found a lot of proof, supporting my belief about a particular stock, bond, or mutual fund. Then, it didn’t work out as it was supposed to, I panicked, and suddenly I found tons of material, supporting the opposite.

Information bias is a distortion in the perception of human beings. If we have an opinion of something, we unconsciously search for information that supports this opinion, or it seems to be dominantly present. As such, we may make wrong decisions. Information bias often exists since people want to go with the flow, or the masses. Not going with the masses might mean making a fool of yourself, or being put off as ridiculous.

Selling too early, selling too late

Being successful in the stock market often means limiting potential losses and letting profits rise. At some times, I have been guilty of doing the exact opposite: selling very early with a small profit, but selling much too late, letting my losses be driven up.

Relating to stocks, we often become very excited at small changes, and the bigger the change, the more relaxed we get. Therefore, many people tend to sell early at a small profit, being euphoric that they made a profit and fearing that they might lose it. On the other side, these people might become scared at having a small loss, hoping that the stock will recover. If this does not happen, often people tend to think that it would be useless to sell the stock now anyway, and the further the stock falls, the less emotional and involved they become. It is not unusual, that these people sell the stock at exactly the least beneficial point: when it has reached its bottom.

Making up for losses

Luckily I have been largely able to control this. However, many people want to make up for their losses, just as quickly as they occurred. This is very difficult, since a 50% loss requires a 100% profit to make up for it. Many people are willing to take more risks, and invest more money after they have lost some, just to make up for it. Some go bankrupt in their attempts.

I know I have a lot to learn, and I will certainly get more into this topic and write about it occasionally. Until then, I can recommend the following articles I found, which I find worth reading:

• Portfolio Management: The Pitfalls of Behavioral Finance
• Behavioral finance to the rescue?
• Why Smart People Make Big Money Mistakes (and How to Correct Them)

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