Neuro-finance

A widely accepted fact of financial planning, as a profession, is that it is two-thirds moral and ethical skills; from fields such as psychology, sociology, and philosophy; and one-third technical and analytical skills; stemming from finance, economics, and mathematics. If this is true for financial planning professionals, shouldn’t it be equally true for each of us as we work through our financial lives?

On Monday, I was again privileged to hear Douglas Lennick, CFP® address the Annual Meeting of the Financial Planners’ Association in Boston, MA. I believe his insights into how our cognitive, neurological, and emotional “parts” work together is very relevant to our decisions stemming from the current financial malaise (i.e., mess!). First, he asked us to draw the diagram to the right on our notepads. Then, he indicated that every time we are stimulated to act; the cognitive, neurological, and emotional facets of our mind work together to decide on our reaction to the stimulus. If we do not like our actions in response to certain stimuli, we must consciously try to change the paths our decisions take between and among the three spheres. (He used the analogy of the mind being a large grassy field, where trails have been worn by our repeated reactions to stimuli. If we consciously try to use a new path, eventually a new trail will be present, while grass grows over our old behavioral pathways.)

Then, he said the punchline, “ Everytime we receive a new stimulus, we first react emotionally” which, at times, can be quite distant from cognitive, rational thought. Certainly, the current stimulus of the credit collapse has had its share of emotional reactions. The question is, What do we do next? He gave us two rules and four skills to practice. First the rules, then the skills.

Rule #1: Always be prepared for the certainty of uncertainty.

Rule #2: Always make financial decisions based on personal values.

If you want to change your responses to stimuli, you must be guided by your personal values. He encouraged us to work with our “clients” to help them create new pathways in their response to stimuli.

To begin, one must recognize one’s own experiences of the relationship between one’s emotions and cognitive thought. Do you see the current situation as a threat or an opportunity? Are you running from it, sticking your head in the sand, or embracing it and trying to learn from the situation? What is your emotional response?

Second, reflect on the degree you are meeting your responsibility to prepare for periods of uncertainty. Reflect on the big picture. Consider your goals, your current financial plan, your portfolio’s diversification, your insurance coverages, your family, and get yourself ready for the long-term. Is your plan consistent with the values and the principles you wish to display to others?

Third, reframe your self-talk to look for possible biases that might exist. Ask youself if you’re being too emotional in your response and strive to create a construct for your future decisions that can exist without these biases.

Finally, respond with a decision that is consistent with your moral principles and implement a plan that is consistent in supporting your goals.

The best place to start revising your emotional, cognitive, and neurological makeup is to decide on the rules that will guide your journey. Have you listed your primary values? Have you written them down? Do you reflect on them daily? Take a moment and list your primary values and periodically ask yourself if you’re making decisions that are consistent with those values. Mr. Lennick listed his: family, happiness, wisdom, integrity, service, and health.

If our fellow citizens on Wall Street and in the mortgage security business would have done this exercise and lived by it, my guess is that the decisions rocking the world may never have been made. Think about it. If a lack of principles and values can create financial distress for millions, couldn’t it be the case that an abundance of principles and values has the possiblility to create Financial Success for one?

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

Dollar Cost Averaging – A Primer

Learning how to invest often seems like a daunting and frightening process, and all too frequently financial professionals use a language of their own to potentially confuse, rather than educate, their clients. Many financial professionals feel their livelihood may be threatened if the larger society understands the principles to building wealth. Other advisors might fear that their client will not find value in the relationship, if the investment professional is telling the client what the client already knows. Such beliefs have been a bane to individual investors and the industry as a whole for decades, but there is a way to combat the confusion that comes with being in unfamiliar territory. It is simple. You learn the language. For example, understanding the concept of dollar-cost averaging is one of many strategies that can help you make sense of investment advice and judge the quality of the recommendations received.

As most people know, investment markets tend to trend higher over extended periods of time. Many forget that picking the tops and bottoms is everything but it is impossible - even for the most seasoned of market timers. Let us say that again, Market timing is everything but it is not possible. Moreover, we may enter periods where investments decline for years at a time. While most know these facts, the fear associated with potential declines keeps many people from ever entering the realm of investing. There is, however, a solution and many of us use it each time we make a deposit to our 401k or 403b retirement plan.
Whether you call it that or not, dollar cost averaging is an investment discipline in which investors commit a specific amount of money to their portfolios at designated intervals, say monthly. This helps to mitigate volatility and ensures that investors purchase more of the underlying securities when the price is low, and less of the security when the price is high. Buying low and selling high is the key to investment success and this strategy helps take care of the buying half. Moreover, once you start, you don’t have to think about it other than to rebalance to keep your investments diversified.

As an example, let’s say you invest $50/month into a mutual fund. If the fund is trading at $50 a share in the first month, you will buy 1 share of the fund. If the share price takes a precipitous decline the second month and is now trading at $25/share, the same $50 will purchase 2 shares the second month. You now own 3 shares at an average price of $33.33/share and you have bought twice as many shares at $25 as you did at $50. In other words, you are ensuring the purchase of more shares at lower prices.

Let’s say in the third month the price is again $50. Had you put $150, as a lump-sum, in the market the first month and not dollar-cost averaged, you would have purchased 3 shares and they would be worth what you paid for them, $50, a 0% return. On the other hand, had you dollar cost averaged at $50 per month for the three months, you would own 4 shares, worth $200 for a 33% return on your invested assets or $150. You see, as long as a lower price exists prior to the final price, you will have more shares purchased at the lower price to enhance your return. There you have it, Financial Success in a nutshell called Dollar Cost Averaging.

Heath Lauseng[i] and
Robert O. Weagley, Ph.D. CFP®
Chair, Personal Financial Planning
University of Missouri
Columbia, MO 65211

Thursday, 4:23 p.m., CDT

If you’re writing a Financial Tip of the Week, in this economic environment, you want to wait until the last minute to see what, if anything, is going to change. These are dramatic times, or as Charles Dickens wrote in The Tale of Two Cities (1859):

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.

The above says it well for how many have felt over our lives. Yet, for most of you, today’s news must seem like a harbinger of doom as you work to manage the resources of your household, while preparing for retirement or college expenses. On the other hand, you may be near your beginning and are actively preparing yourselves for jobs after college or are planning on investing in yourself by attending college. (College education continues to be one of the best investments one can make in one’s self.)

Rather than try to provide you with my thoughts on this week’s events and to avoid talking about another financial topic of interest – many exist but nothing trumps what is going on in Washington and Wall Street – I thought I bring you some bullets of wisdom from the Sage from Omaha, Warren Buffett.

Warren Buffett was interviewed on CNBC news on Wednesday morning about his surprise investment of $5 billion in Goldman Sachs (complete transcript: http://www.cnbc.com/id/26867866/site/14081545/ ). Some bullets, from his comments:

·If I didn't think the government was going to act, I would not be doing anything this week. I might be trying to undo things this week…..government will do the rational thing here and act promptly. It would be a mistake to be buying anything now if the government was going to walk away from the Paulson proposal. (Editor’s note: As of this afternoon, Congress has supported Paulson’s proposal.)

·Last week we were at the brink of something that would have made anything that's happened in financial history look pale.

·…the economy and the financial markets, but they're so intertwined that what happens, they're joined at the hip. And it doesn't pay to get into horror stories in terms of naming institutions or anything. But I will tell you that the market could not have, in my view, could not have taken another week like what was developing last week. And setting forth the Paulson plan, it was the last thing, I think, that Hank Paulson wanted to do. There's no Plan B for this.

·…it's everybody's problem. Unfortunately, the economy is a little like a bathtub. You can't have cold water in the front and hot water in the back. And what was happening on Wall Street was going to immerse that bathtub very, very quickly in terms of business.

·…a collapse of the kind of institutions that were threatened last week, and their inability to fund, would have caused industry and retail and everything else to grind to something close to a halt.

·…you have all the major institutions in the world trying to deleverage. And we want them to deleverage, but they're trying to deleverage at the same time. Well, if huge institutions are trying to deleverage, you need someone in the world that's willing to leverage up. And there's no one that can leverage up except the United States government (underline added for emphasis). And what they're talking about is leveraging up to the tune of $700 billion to, in effect, offset the deleveraging that's going on through all the financial institutions.

·…if I could buy a hundred billion of these kinds of instruments at today's prices, and borrow a non-recourse $90 billion, which I can't, but if I could do that, I would do that with the expectation of a significant profit. (Editor’s note: This implies that the $700 billion price tag may be substantially reduced as the government oversees the disposition of these distressed assets.)

·But they (the U.S. government) have the ability to borrow. They can borrow much cheaper than I can borrow. They can borrow unlimited. They don't have covenants. They don't have -- I mean, they are in the ideal position…..I will tell you that the buyers of the instruments these days are going to do better than the sellers…..In fact, one thing you might do is, if someone wants to sell a hundred billion of these instruments to the Treasury, let them sell two or three billion in the market and then have the Treasury match that, for what they pay. You don't want the Treasury to be a patsy.

·But I'll tell you, with Hank Paulson on top of it, you couldn't have any better guy to do that.

I’ll join Mr. Buffett with my hope and prayer for a growing public confidence in the wisdom of our leadership and for an end to the foolishness of recent history. I’m sure many of you join me in a sincere desire to see us learn from this lesson of the markets. In particular, we must remember that ethics and principles have a place and that place is in the forefront of our personal and work decisions - each and every day. If principles guide us, the result will be Financial Success…with an Abundance of Wisdom.

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

Freddie, Fannie, and You

What a year! What a week! What a day! Everyone I have spoken with in the finance professions is shocked and awed by the events of the past week. Moreover, they are in various stages of grief or bewilderment as they ponder the future for their clients, as well as themselves. I thought it might be healing (at least for me) to put some thoughts on the screen with regard to what the bailouts mean and what I’m considering to be good advice…

The bailout of Freddie Mac, Fanny Mae, and AIG; as well as the purchase of Merrill Lynch by Bank of America was done, according to Treasury Secretary Paulson, to stabilize financial markets, support mortgage financing, and protect taxpayers. Most of us wonder what is in it for us, as we watch our portfolios shrink as the result of others’ actions. Many also question the government acting in such a way, apparently in contrast to our belief in the free market system. Good medicine sure can taste bad.

First, the Treasury could not let Freddie Mac and Fannie Mae fail. These shareholder-owned companies are actually the creation of the federal government charged with guaranteeing the mortgages issued by private lenders and government agencies. Investors around the world believed these diversified portfolios of mortgage loans to be safe and that the U.S. government guaranteed them, at least that was their perception. These securities were considered to be an almost-as-safe-as-Treasuries investment with a higher return and, together, represented about $6 trillion of the U.S. mortgage market. All this was good. Business in housing boomed for years. Subprime mortgages and speculation began to flourish…until the housing slump. (It does seem to rain on every financial parade.)

As the housing slump wore on, Fannie and Freddie began spending their capital to back these defaulting mortgage loans. In late July, an independent audit revealed that as much as $50 billion was needed to shore-up these firms’ capital accounts. Given the large amount of U.S. debt that is held by other countries, and our ever increasing need to borrow, it was concluded that it is in the best interest of the U.S./world for the U.S. government to intervene. We could not let our credit rating fall. Moreover, without Freddie and Fannie able to participate in the mortgage market, it is estimated that housing prices might fall another 10% to 20%, as it becomes harder to qualify for a mortgage and liquidity is reduced. (Trust me, this is not good news, even if you are a young, first-time homebuyer.)What should you do?· Look at your net-worth statement. If you have debts costing you double digits rates of interest and you’re having trouble sleeping, pay off some debts. Your net-worth will be intact and you’ll be able to sleep.

· Make sure your portfolio is diversified and well balanced among asset classes. Try to resist the urge to look for the “phoenix-investment” rising from the recent carnage. While I do think there are investment bargains in today’s market, do not abandon the discipline of diversification. Do not invest money in a “bargain” that you cannot afford to lose. (In our “in-class” portfolio for my investments class, one of my students “purchased” Fannie Mae, Lehman Brothers, and AIG at the beginning of the semester. Oops.)

· Mortgage rates are beginning to fall. If you’ve an expensive or exotic mortgage that you’d like to abandon, explore your options to refinance. Perhaps, this is time to buy that home. Perhaps, this is a good time to add a real-estate investment to your portfolio.

· Remember that this will pass. Continue to focus on the things that really matter and that define you to be a success. In many cases, real success is much more than financial success.

NEWS FLASH: While I was writing, a report has surfaced that a new entity, similar to the Resolution Trust Corporation, is being considered to handle the nation’s bad debt. As a result the Dow Jones Industrial Average is up 410 points, or 3.86%. What a day! What a week! What a year!

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211