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Rational and irrational fears: What’s the difference?

 


Rational and irrational fears. How do you know the difference between the two?

From August of 1980 to April of 1988 I was a computer programmer in the United States Army. I was responsible in part for creating the Y2K bug that was the "boogie man" at the turn of the century.

When the year 2000 approached, the hysteria of this "bug" was apocalyptic.

At the stroke of midnight Dec. 31, 1999, the whole world was supposed to come to an end. Trains were going to crash into each other, the banking system would come to a screeching halt, and the end of the world was just around the corner.

I woke up on Jan. 1, 2000, and celebrated my son's birthday just like every other year since the day he was born 14 years before. It was a glorious day.

College football dominated the landscape that day. The apocalypse never happened. The Y2K bug was an irrational fear.

Since I wrote some of the code, it was really quite silly actually. But that did not stop many major corporations from spending five years-worth of money to upgrade their computers and networks. This contributed to the "dot-com" bubble. The market has since recovered and while many tech companies did not survive, many household names obviously did.

This is an Insightful Investing column, and I want to focus on investing. Wise investing is a matter of understanding risks and overcoming fears. Fears sometimes are founded on unwarranted beliefs. Often, the risks we fail to understand are the risks that get us into the most trouble.

In words that are largely attributed to Mark Twain: "It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so."

Nassim Taleb, in his book “The Black Swan,” says that as humans, we have a horrible record of anticipating what we don't know. And the negative things we don't know have a bigger impact on us than the positive things we don't know.

In my own words: "How do I protect myself from the negative events that I know nothing about? Since the positive events, I know nothing about will make my life better but the negative things could possibly destroy me. It is only rational to do everything in my power to 'plan for the worst and hope for the best.'"

Here is the number one fear of many of my clients: Will I outlive my money?

This is a rational fear. It is rational because to a large degree it is a math problem. Every investor is facing what I consider the three biggest money threats; sequence of returns, inflation, and longevity.

These are threats because, for the most part, we have no control over any of them, with the exception of longevity. And our control over longevity is meaningful but not total.

Inflation and longevity are self-evident. The sequence of returns is not.

In it's simplest form, the sequence of return on your money is critical five years prior to retiring and five years after. Most people can’t afford to take big losses during that critical time. Much of my time is spent working on the math for those nearing or in retirement. You and I both know people who needed to go back to work in 2010 because they did not understand this risk.

In our neighborhood, Mukilteo, Boeing has eliminated the "defined benefit" program for new hires. In fact, they are one of the last companies that even offered them. Most corporations abandoned defined benefit programs decades ago.

Some labor unions still have them (side note: my son belongs to Local 191, the books are clear for anyone looking for work).

This has placed the onerous task of making sure you don't outlive your money squarely on your shoulders. Part of my job is to help educate you on this abstruse risk.

Not understanding the sequence of return risk has the potential of sending you back to work after a lifetime of saving. There are strategies and answers out there to mitigate this risk. Make sure you entertain them.

I don't give specific advice in this column as it is a compliance issue. However, here is a link to a recent column that gives you a taste of what I am talking about: thebalance.com/how-sequence-risk-affects-your-retirement-money-2388672.

Normally I can identify irrational fears after the fact. Call it 20/20 hindsight. I am like most people in that sense. I do however think focusing on known fears is rational.

Plan for the worst and hope for the best.

OK, that is all for now!

Jeffrey Moormeier of JG Moormeier Financial is a Mukilteo-based financial advisor affiliated with KMS Financial Services, Inc. an SEC registered investment adviser. His column does not represent the opinions of KMS, nor is it an official prediction or recommendation of any kind. The opinions expressed in this column are generalizations. For advise catered to your specific financial circumstances, contact Jeff directly at jeff@jgmoormeier.com or 425-931-8898.

 

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