Like many financial advisors, I am often called on to help my family and friends with financial matters. In my experience advising different generations and age groups, there are some common questions and problems that keep coming up, especially in relation to investment fear and greed. What I tell them—and what I wish trusted advisors would tell their existing and prospective clients—depends on where they are in life.
To the Millennials: “Good Times Don’t Last Forever”
Investors coming of age today have seen markets at record highs and a strong economy. Lots of people have made lots of money in bitcoin. But, as I’ve discussed on my blog, it sounds to me a lot like the dot-com boom. People then, especially those who reached young adulthood in the 1990s, believed the world would change—and were correct—and that the good times would last forever—and were wrong.
Millennials who were not working or investing in 2008–2009 have known only the bull market of the past nine years; they may count on the good times continuing—and invest accordingly. This “greed” may seem rational to them given the boom conditions they are familiar with. That was me in the 1990s. I took risks investing in the tech bubble, knowing full well that valuations were ridiculous, but I was convinced I would know when to get out. I didn’t. The lesson I took away from that experience was that I would have been better off with a disciplined, diversified portfolio. I would have made less, but I wouldn’t have lost so much either.
Investing in equities, then, may not be a problem for young people right now. It certainly wasn’t for me. The problem lies in tempering that greed with at least a little fear. If you suspect the good times won’t last forever, you will diversify your portfolio and rebalance regularly, rather than chasing the hot asset.
For your millennial clients, by all means, help them take risks and invest aggressively—but within reason. Their best chance for success lies in a solid, regular investment program, properly diversified, that will grow naturally over time. They may aspire to retire tomorrow, but unless they are very lucky and have great timing, it doesn’t work that way. Millennials should invest in a disciplined way with a long-term perspective.
To Generation X: “Balance Is the Key”
This is my generation, the slightly less young investors who lived through the dot-com boom and subsequent crash, only to get hit hard again by the financial crisis in 2008–2009 and the Great Recession that followed. We have seen both investment fear and greed shake the economy and markets twice now, and we’re feeling a bit whipsawed. At the same time, we are now looking at both our parents’ lives—which are affected by their financial decisions—and our own pending retirements.
The challenge we face is not getting caught up in either the fear or the greed. We need to be in the market; we know that—but we also know exactly what might happen if things turn down. How do we strike a balance between the two given the very real obligations we have?
One way to help Gen Xers manage investment fear and greed is to assign assets to specific objectives that match their time frames. That way, they can focus on what matters: meeting goals, which, after all, is why they are investing in the first place. By assigning different pools of capital to different goals, using different portfolios, Gen Xers can explicitly match the risk of each bucket with the time frame of the goal.
For example, I have an emergency fund that covers several months of living expenses that I keep in cash. That makes it easier to invest my son’s college account, with a 15-year horizon, on a riskier basis, and my retirement assets, with a 20-year horizon, on an even riskier basis. Knowing that my shorter-term needs are met frees me psychologically to accept the greater risk in the longer-term portfolios. The need to invest is just as real for Gen Xers as it is for millennials, but the risk tolerance—in both temporal and psychological terms—is not as strong. We need to know how and why to manage around that difference.
To the Baby Boomers: “Return of Capital Is as Important as Return on Capital”
It’s no secret that losses hurt more as we get older because we have both less time to recover and a deeper knowledge of just how bad things could get. Because of that, I consider the potential for loss as a major, but often ignored, measure of risk. This is particularly true for the retiring boomers.
Risk is commonly measured by how much returns vary over time. Fair enough, but the way I see risk is in drawdowns: how much have I lost from the peak? When I make money, I figure it is mine—so any losses hurt. It doesn’t work that way, of course, but as I get older, the idea of return of capital becomes just as important as return oncapital. Losses are theoretical until they happen, and what I recommend for my parents and others is to plan around them. Boomers are typically entering the withdrawal phase of their investing careers. What they have is what they have. Any losses will be much harder to make up and, therefore, much more damaging.
Helping boomers keep a focus on the downside, in terms of what a loss might mean, is essential. Falling down when you are young is usually not a big deal. As you get older, the probability of a broken hip rises, and people walk more carefully—unless they are in a hurry. Being in a hurry won’t necessarily get them to their destination any faster, though. Our boomer clients need to keep that in mind in their financial journeys as well.
To Older Investors: “Fear Could Be Your Best Friend”
Here, the need for risk aversion—for avoiding losses—becomes even more intense. Investors in this age group are typically beyond working age, need the income, and have no real time to recover from losses. What they have is very likely all they will ever have.
Greed, however, is eternal, especially if what you have isn’t enough. For these investors, help them understand that there is a big difference between bad and worse. They should think carefully about what any loss would mean. Use fear—it could be the best friend your clients have in this context.
Managing Investment Fear and Greed
For all generations, investing is always about fear and greed, but the impact of each varies. When investors are younger, with a multidecade horizon, they really do have nothing to fear but fear itself. As investors grow older, greed has to take a back seat, as fear—given these investors’ need for income and lack of time to recover—becomes the more rational choice.
When advising different generations of clients, our job, really, is to help investors cope with the weaknesses we all share when it comes to investing. A lack of planning, emotional decision making, and failing to design my investments to help meet specific objectives—in short, fear and greed—have cost me quite a bit of money over the years. The more you can help your clients avoid these mistakes, the better off they—and you—will be.
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This post originally appeared on Commonwealth Independent Advisor, a blog authored by subject-matter experts at Commonwealth Financial Network®, the nation’s largest privately held Registered Investment Adviser–independent broker/dealer. To subscribe, please visit http://blog.commonwealth.com/.