Behavioral Finance

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How To Avoid Common Investor Mistakes
People often make financial decisions based on impulses and market shifts
How To Avoid Common Investor Mistakes People often make financial decisions based on impulses and market shifts In 10 seconds Want to invest wisely? Start with why you’re saving and investing: A goal. Don’t overreact to short-term gains and losses. And keep your cost-of-living low, even when your income increases. In 1 minute Even savvy investors can let their impulses get the best of them. By understanding how our natural tendencies can cause poor financial decisions, we can teach ourselves to make wiser choices. Goal-based investing means identifying what you need money for in the future, and aligning investments around a tangible outcome. Having a goal helps you decide: Where to invest How much to invest How long to invest Short-term losses are part of the process. If you constantly check your portfolio’s performance and react to short-term losses, you’ll likely hold yourself back. Instead, focus on the process that can yield long-term gains, and give your investments time to grow. “Lifestyle creep” can easily throw off your plans for the future. As your income increases, try to keep your cost of living about the same. If your regular spending increases, you’ll need to save and invest more to maintain your new lifestyle. That’s the short version. Learn more about common investor mistakes below. In 5 minutes In this guide we’ll: Explain how biases lead to bad financial decisions Look at common mistakes investors make Show you how to avoid these investing mistakes The source of common investor mistakes. Investing mistakes are often rooted in our natural reactions. Let’s face it: We don’t always react the right way to information. And when enough investors have poor reactions, it can affect the entire market. Behavioral finance is a field of study that looks at how psychology affects financial decisions. It helps us understand why investors make common mistakes, so it’s easier to avoid them. But don’t worry—it doesn’t have to be complicated. Some of the most important lessons from this field are surprisingly simple. Try to invest with a goal in mind. Investing is one of the smartest financial decisions you can make. But a lot of investors start without knowing what they’re working toward—and that’s, well, less smart. When you don’t know why you’re building a financial portfolio, it’s a lot harder to know things like: What account types to use How much risk to take on How much to invest each month How much you can spend without feeling guilty How much total money you’ll need to save How long you need to invest Instead, start with why. What do you want to be able to spend money on in the future? When are you going to use that money? These aren’t just stocks and bonds. Your investment is a future downpayment on a house. Your dream car. Retirement. College. Real things and experiences you want to be able to afford. Having a goal takes the guesswork out of investing. You can calculate exactly how much you need to invest based on the range of potential outcomes. It’s also easier to decide where to put your investments. Retiring in 40 years? Take more risk and put more in stocks. Hitting your goal next year? Play it safe. When you know how much you need to invest, break it into monthly chunks and automate your deposits. With recurring deposits, you're basically “paying yourself first” before worrying about other expenses. That way, you won’t talk yourself into skipping a month. (Which turns into two months, then three, and—oops, it’s been a year.) Focus on the long-term. When you invest, you’ll have short-term losses here and there. It’s inevitable. And most times, it’s a mistake to make adjustments when your portfolio loses value. You can’t predict tomorrow’s performance based on yesterday’s. Even during the last ten years of steady growth, investors had to endure short-term losses at some point every year. Given enough time, the market trends upwards. And investments that perform poorly one day can easily make up for it the next. But that’s not what most people think about when they see their portfolio lose 15% of its value. They panic. They make sweeping changes, reinvesting in funds and stocks that had short-term gains. And those big emotional decisions often do more harm than good. Investing is about long-term gains. Short-term losses are simply part of the process. Don’t panic every time there’s a loss, and you’ll likely see bigger long-term gains. Watch out for “lifestyle creep.” You don’t have to live frugally to be a successful investor. It helps, but the bigger issue is making sure that as your income increases, you stay in control of your lifestyle and spending. Most people see small pay increases over the course of their lives. 3% here. 8% there. When your regular spending increases with your income, it’s known as “lifestyle creep.” It can easily get in the way of saving enough to achieve your goals. If you have a lower income, it makes sense that more of your money goes toward basic necessities. But lifestyle creep happens when you gradually spend more on things you don’t need. Entertainment. Hobbies. Take out. Every time you increase your regular spending, your lifestyle costs more to maintain. You’ll likely need to save more for retirement. Your emergency fund may need to grow, too. Lifestyle creep is an even bigger problem if you started investing with the expectation that you’d invest more later. Some people feel intimidated by their goals, so they plan to increase the amount they invest when they start making more money. That’s fine—as long as you actually do it. Temporary increases in spending are OK. But as you make more money, don’t let a more extravagant lifestyle sabotage your goals. Mistake-free investing You want to invest because you want to use your money wisely. At Betterment, we help you do that by building your portfolio around your goals and setting you up to play the long-game. Right from the start, you’ll know our suggested allocation for your portfolio, how much to invest each month, and what outcomes you can expect based on your input. Schedule recurring deposits to help you stay on track, check your progress, and make adjustments at any time. -
Betterment Customers Stay the Course, Steer Clear of Behavior Gap
Research from Betterment’s behavioral team shows that most investors with Betterment achieve ...
Betterment Customers Stay the Course, Steer Clear of Behavior Gap Research from Betterment’s behavioral team shows that most investors with Betterment achieve full investment returns and do not attempt to time the market. Betterment strives to help customers reach Behavior Gap Zero—a way of saying that bad behavior doesn’t interfere with achieving optimal returns.1 To help our customers reach that goal, we seek to understand their motivations and decisions, and how those actions can make an impact on their investment returns. However, measuring that impact is a multifaceted task, so we are starting with one simple question: How do allocation changes, or changing the weight of stocks to bonds in a goal, affect returns? Under what circumstances are customers making allocation changes, and are customers improving or reducing their returns with these changes? Key Finding: Market Timing Hurts Returns After sifting through the data, we found these key points: In 78% of accounts, customers made less than one allocation change per year, consistent with occasional changes in financial circumstances. Across all accounts, 67% of customer accounts have Behavior Gap Zero. Account holders who are more active appear to make allocation changes in reaction to the market, and underperform as a result. We observe an average behavior gap of 22 basis points across all accounts; however, we noted a skewed distribution, and 74% of accounts are better than this average. Below, we first detail the ways our smarter technology is making allocation selection easier than ever for investors. Second, we review the results of our behavioral research. Together, these illustrate the unique ability and dedication we have at Betterment to understanding and assisting with the behavioral components of investing. What makes this data unique? Most existing studies of the behavior gap in investing look at cash flows into and out of different funds. This is a necessity because most investing platforms require that an investor move funds from one vehicle to another to adjust risk. Existing studies generally show that those cash flows mistime the market, on average: rushing in after periods of success and retreating when returns are down. But cash flows are a muddy measurement of risk preferences. Investors may move assets because of fees, manager reputation, to consolidate investments, or because they need the money to spend. For investors, adjusting risk allocation at Betterment is as simple as dragging a slider to change the proportion of stocks and bonds within the portfolio. As a result, we can focus on how investors change allocations while filtering out other confounding changes, which allows us to measure the resulting impact on returns with great clarity. Automated Allocation: A New Paradigm We understand the reality of changing financial circumstances and accordingly, we make our allocation change as easy and efficient as possible. Adjusting portfolio allocations has traditionally been full of frictions: phone calls to advisors, fees for trades, and uncertain tax consequences. Betterment customers experience none of those frictions, and as a result, have a new level of freedom and power to adjust their allocation to meet their financial needs. Imagine a career change that pushes plans to buy a house back by three to five years, or a family change, such as a divorce or death, that makes retiring a few years later seem like the right decision. These changes in the time horizon of the investing goal mean that stock allocation should be increased accordingly. On the other hand, if an investor needs the money sooner than originally expected, more bonds are appropriate to minimize uncertainty around the withdrawal date. Betterment reduces certain costs and barriers to allocation changes (e.g., fees, fund choices, taxes) so that our customers have the right portfolio for their financial situation. What we don’t want to encourage, however, are allocation changes in response to market movements or guesses about what the market will do in the future. As long-time Betterment customers know, we discourage market timing at every turn. With this research, we wanted to answer two questions: Are customers trying to time the market? If so, how is that affecting their returns? Examining Customer Behavior The data below shows allocation changes as they coincide with market performance (dark blue line) during just the last two quarters of 2014. Each bar shows the average direction and magnitude of allocation changes over the previous seven days. Note that these averages include only the small number of customers who made a change over the 7-day period— typically five out of every 1,000. When focused on the tiny subset of customers who were active, we do see some behavior that looks like market timing. How do we know this? If these investors were making allocation changes purely in response to idiosyncratic changes in their financial circumstances, the average change would stay close to 0% and we wouldn’t see any correlation with market performance. Allocation Changes and Market Performance Data Shows Subset of Active Users Only We see that changes followed the market to some degree in the second half of 2014, but what about a more systematic trend? If we use all of our data since 2010, we can look for such systematic patterns.2 The plot below shows the proportion of allocation changes moving toward stocks or bonds based on market performance in the preceding week. We see that when the market is up between 0% and 3% in the preceding week, the average change increases the stock allocation by 6%. When the market is down more than 2% in the preceding week, the average allocation change is toward bonds by 5%. Remember, more than 99% of customers do not make an allocation change during a given 7-day period, so this pertains to the decisions of the small number who do make changes. Proportion of Allocation Changes Moving Toward Stocks or Bonds Based on Market Performance How is this affecting returns? Perhaps these active customers are actually improving their returns by making changes? To measure the effect of allocation changes on a customer’s returns, we compared the returns the customer experienced as a result of actual allocation choices to an individualized benchmark. For the benchmark, we used the average time-weighted allocation chosen by the customer. Then, we compared each customer’s actual returns resulting from actual allocation levels over time to the benchmark: the returns that would have resulted if the customer had been at the average allocation constantly from day one. In both cases, we used time-weighted returns, so cash flows into or out of the account did not have an effect. As an example, imagine a customer who funds a five-year home-buying goal and sets the allocation to 70% stocks. After one year, the customer increases the allocation to 95% to chase the performance of surging U.S. equity markets. A more volatile second year makes the prospect of losses more salient, and the customer sets the allocation back to 70%. By the end of the third year, the account had earned 18%. In this analysis, we compare that actual 18% time-weighted return to a hypothetical account with a constant 78.33% allocation over the same period (the time-weighted average of 70, 95, and 70). By doing this analysis on every account, we find making allocation changes reduces returns, on average. By doing this analysis on every account, we find making allocation changes reduces returns, on average. Across all Betterment accounts, the mean gap between actual returns and the average allocation returns was 22 basis points. However this includes all the accounts that made no allocation changes, and whose gap would by definition be zero. Looking only at the accounts that made at least one allocation change, the average gap is 41 basis points. The figure below shows that each additional allocation change (up to four) increases the average behavior gap by about 16 basis points. Only 22% of accounts have made more than one allocation change per year. Nearly half have never made even one, so there is no possibility of a behavior gap, as we define it. Overall, two-thirds of customers have no gap, and three-fourths have a behavior gap smaller than the 22 basis point average. Behavior Gap and Allocation Changes IRAs Are Different Interestingly, we see customers making fewer allocation changes in their retirement goals in IRA accounts, and their returns are closer to the ideal as a result. Betterment customers make 48% fewer allocation changes in their IRA accounts and see 50% smaller behavior gaps, on average. We see two potential explanations for this difference. First, it’s likely that our customers’ retirement horizons don’t change very often, so there are fewer legitimate allocation changes than in many of the shorter-term taxable savings goals. Second, the findings are consistent with prior research showing less activity in retirement accounts, possibly because they are perceived as more “off limits.”3 It’s worth noting that a preference for changing allocation inside a taxable account versus an IRA, all else being equal, is highly tax-inefficient behavior, as investors are not taxed on realized gains inside an IRA. The returns analyzed here are not after-tax, so the findings actually understate the gap that results from frequent trading in a taxable account, which we’ve written about in the past. If an investor is going to market time (and we advise against that!), doing so in a taxable account is particularly ill-advised, as compared to an IRA. How does this apply to individuals? Does this mean that an investor should never make an allocation change? Not at all. If an investor’s financial goals or constraints have changed, an allocation change may be the right thing to do. In that case, we recommend going to the Advice tab in your Betterment account, entering the new time horizon or target balance, and adjusting accordingly. Using allocation changes as a tool to try to time the market, or in reaction to periods of bullish or volatile markets, is where we see trouble. These kinds of changes only make sense if an investor know exactly what the markets will do next, and that is not something most of us should be betting on. 1 The “behavior gap” is a term coined by financial planner and journalist Carl Richards and has become a popular way to refer to the loss of investor returns due to bad timing decisions. 2 While the average market movement has been upward over the period Betterment has been available to investors, it has been marked by drawdowns of up to 20% in the S&P 500 since 2010. 3 Barber, B. M., & Odean, T. (2000). Trading is hazardous to your wealth: The common stock investment performance of individual investors. The Journal of Finance, 55(2), 773-806. -
Women and Money: Bridge The Gap
It’s no secret that women fight more of an uphill battle than male peers in their efforts to ...
Women and Money: Bridge The Gap It’s no secret that women fight more of an uphill battle than male peers in their efforts to reach personal financial goals. $430,480. That’s what it costs to be a woman, according to the National Women’s Law Center. It’s the wage gap that results from a lifetime of being paid less than men. It’s no secret that women fight more of an uphill battle than male peers in their efforts to reach personal financial goals. That nearly half-million dollar wage disparity may be the best known financial hurdle that a number of women face today, but it’s not the only one. Let’s take a look at what other financial hurdles women face, issues they should reconsider, the opportunities they should take advantage of, and what it will take to bridge the gap. The Hurdles You Should Pay Attention To Earning Money The wage gap women face starts with lower pay for comparable work. More time out of the workforce (15% of working years vs. 2% for men), primarily for family caregiving, compounds the problem. On top of that, when women are fired from their role, they tend to take an average 24% pay cut at their next job, as compared to the 1.3% increase men see. Spending Money: The “Pink Tax” Not only do women often earn less for comparable work, they also tend to pay more for comparable goods and services. This so-called “pink tax” is levied on everything from hair care to healthcare. In some cases, it extends to financial products such as mortgages, business loans, and annuities. The Issues You Should Reconsider How confident are you? A mere 9% of women think they are better investors than men, per a recent study. Traditional gender roles had them showing up late to the party on this, so a case of newbie nerves is to be expected. The problem is that this confidence gap results in reduced risk tolerance. Women wait longer to invest and, when they finally do, they tend to stash larger portions of their money in safer, but low earning, accounts. Compounded over time, this more conservative approach can exact a big toll on women’s net worth. Are you considering your life expectancy as much as you should? According to 2017 Center for Disease Control data, the life expectancy for American women is 81.6 years. This means, on average, women get 5 more years than men to enjoy the good life, whether that’s globe hopping, playing golf, or spending time with the grandkids. But it’s also 5 extra years of living expenses to fund. And some of those additional years can be extra costly as healthcare expenses soar in later life. Thanks to the hurdles faced en route to retirement, women are forced to cover these higher costs with a comparatively smaller pool of resources. That can include: Lower Social Security benefits Reduced pension payouts Smaller nest eggs The Opportunities You Should Take Advantage Of Behavioral Finance Is On Your Side On the plus side, some gender differences work in women’s favor as do demographic trends. For starters, studies show that women are better savers than men. In particular, they have higher 401(k) participation rates and those that do participate, contribute a higher percentage of pay. Furthermore, behavioral finance research has found that women are also better long-term investors. That’s primarily because, once invested, they are more inclined to “stay the course” regardless of market conditions. Not only does this reduce unprofitable panic selling, it minimizes fees and capital gains taxes. Additional data suggests that this may ultimately result in generally higher rates of return. Shifting Gender Roles Shifting gender roles are affording women more opportunities to leverage those inherent advantages. With 2/3 now acting as primary or co-breadwinner, it’s not surprising that women, and the men in their lives, want to make the most of that hard-earned money. Accordingly, many are eager to learn about financial planning—92 percent according to one study. This hunger for information has spawned a treasure trove of resources. That includes a burgeoning cadre of role models of all stripes, from finally-debt-free millennial bloggers to women CFOs. Watching these prominent women in finance talk openly and confidently about money is inspiring others to overcome cultural barriers and do the same. The cost of ignoring women is finally dawning on the historically male-centric financial services industry. The push to better serve women remains in its infancy, but an estimated $800 billion missed market opportunity is driving it forward. Bridging the Gap When it comes to gender and money, things are moving toward parity with increasing momentum, and there’s a few steps women can take to accelerate the process even more. Here’s how. Just start. Fear of making mistakes often prompts women to delay important financial decisions until fully versed in the matter at hand. While it’s smart to look before you leap, losing out on the magic of compound interest can be just as costly as imperfect execution. Get smart. Financial education is one of the few investments that comes with little to no risk. These days, it’s easily accessible via a startling assortment of seminars, blogs, podcasts, videos, forums, and more—many free or low cost. Take part. Splitting up your money management “To Do” list with a spouse or financial planner makes good sense, but women should stay intimately involved to ensure their interests are represented. The journey to women’s financial parity is far from over, but the progress has been impressive. And with the collective impact of more and more women taking control of their money, maybe someday “the gender gap” can be relegated to the dustbin of history.
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What A Trip To The Casino Can Teach You About Investing And Risk
What A Trip To The Casino Can Teach You About Investing And Risk Learn the ins and outs of how gambling works from a quantitative investor, and use it to your advantage in investing for the long term. For better or worse, there is a certain thrill involved with gambling that makes otherwise rational individuals make irrational bets. When the Mega Millions jackpot hit $1.6 billion in October 2018, over 370 million tickets were sold—that’s more than one ticket for every person in the United States. Of course, the vast majority of those who bought the tickets knew their chances were slim of winning the jackpot in the end. They probably even realized that, on average, they’d lose money by buying a ticket. What you should know is that gambling is never an effective use of money, and gambling addiction can be a major problem. In this article, we’ll review some ways to think about light gambling, but if you gamble often, we encourage you to talk with an appropriate professional. Even with small-time gambling, it’s important not to wager any more money than you can afford to lose. That said, if you set a reasonable, fixed limit of what you will gamble ahead of time (and stick to it!), an occasional night of gambling in Vegas or an entry into your office Fantasy Football pool can be fun. Of course, it’s even more fun if you win. If you do gamble, here are two things you should keep in mind to help maximize your chances of returning, or exceeding, your stake: know your odds, and size your bets accordingly. Part 1. Knowing Your Gambling Odds One of the important skills to have is knowing exactly what your odds are, and how you can improve them. In a skill-based gambling game, like poker, you can increase your chance of winning with practice, but even games that are completely dependent on luck can have different odds based on strategy. As an extreme example, let’s consider the Mega Millions lottery I mentioned earlier. In this game, players choose five numbers between one and 70, and a sixth number between one and 25. The lottery then draws numbers at random, and players win successively more money based on the amount of correctly matched numbers. Players can win the jackpot if they match all six numbers correctly, and if the jackpot isn’t won at a drawing, the money rolls over to the next drawing. The first thing to note is how miniscule the chance of winning the jackpot is. The total number of possible combinations for the lottery is 302,575,350, meaning you have an eight-times higher chance of flipping two nickels and having them land on their side than to win the jackpot. One strategy that may seem enticing at first is to closely monitor the jackpot and only buy when the value gets very high. Since every ticket costs $2, you could technically buy every combination of numbers for a bit more than $600m, seemingly guaranteeing a profit if the jackpot exceeds that number. However, an important caveat is that the jackpot is split between all winners, and a split jackpot would ruin what seemed like a sure win. Nonetheless, the prospect of a large jackpot is enticing. Using LottoReport.com’s data from the 97 Mega Millions drawings between December 2017 and November 2018, we found a pretty clear relationship between jackpot size and number of tickets sold: Relationship between Mega Millions Jackpot Size and Tickets Sold If we assume that each person randomly chooses the numbers on their ticket, we can pretty easily calculate the odds of a split jackpot (using the same set of data): Mathematical Chance of Winning as Jackpot Increases in Value At a jackpot size of just over $1 billion, it becomes more likely than not that someone will win the grand prize. Somewhat more counterintuitively, the probability that someone else will win the jackpot given that you also won the jackpot is about the same, i.e. around 50% if the jackpot is over $1 billion. This means that there is probably some “sweet spot” in which the jackpot is small enough that not as many people decide to buy tickets, but still large enough to maximize your possible returns. Part 2. Sizing Your Bets The second skill you should have is to know how to size your bets. Even with great odds, most people place odds that are too conservative, hampering their potential winnings, or too aggressive, increasing their risk of losing money. In one study from 2016, participants were given $25 and were allowed to bet on a biased coin that had a 60% chance of landing on heads. Even though the participants were given even odds and the probability of winning was high—i.e. the game was stacked in their favor—the majority of the participants performed suboptimally, with 30% of them going bust within 30 minutes. Their mistake was unsound bet sizing. You can view bet sizing as a spectrum of risk-seeking behavior, where we have the most conservative option at one end—don’t bet at all, no matter how good the odds are—and the most aggressive on the other—bet the farm (or better yet, mortgage the farm and bet that money too!) on any gamble, no matter how long the odds are. Mathematically, both of these behaviors are well below optimal if you want to maximize your betting winnings, and the optimal strategy exists somewhere between the two. The optimal bet-sizing strategy is a matter of math. John Kelly found the optimal solution in 1956 for how to size your bets if you want to increase your wealth optimally in the long-run. The so-called “Kelly Criterion” can be described in a short formula. Then, we can test out the formula with simulations of what individuals’ gambling circumstances might actually be like. What we’ll find at the end is exactly what casinos already know well—that typically the best gambling strategy is to only gamble a small amount of your wealth, while diversifying your bets. Using the Kelly Criterion The mathematical formula for the Kelly Criterion is: f = (pb – q) ÷ b where f is the fraction of your bankroll that you should bet, p is your chance of winning, q is your chance of losing (i.e., 1 – p), and b are your net odds, i.e. the amount of money you would win by betting $1 and winning. For example, in the biased coin study described earlier, the participants should have bet (60% x $1 – 40%) / $1, which equals 20% of their bankroll. The participant who follows this strategy could expect their wealth to grow by 2% per bet, on average. Simulating Possible Outcomes We can test this out by running a Monte-Carlo simulation, in which we simulate a strategy thousands of times to estimate the efficiency of a strategy. Assuming that each player can play 300 games in the 30 minutes allotted to them, and that the players’ “wealth” is capped at $250, how well do the players do if they follow the optimal bet sizing strategy? Let’s simulate the results for one player first: This player had a very volatile and bumpy start, but by following the Kelly Criterion they managed to maximize their wealth after a bit less than 100 coin tosses. Let’s see what happens when we simulate the wealth of 10,000 people: When we look at the summary results above, things look very rosy. Over 90% of players end up maxing out their wealth, and no-one went broke when they followed the Kelly Criterion. However, what is missing from this chart (compared to the previous figure) is the amount of volatility in the results. If you look back at the single individual, you can see just how volatile their wins and losses were. At any point, a bad run of three tails in a row would cut your wealth in half. This sort of drawdown is a rare event in stock markets and can make even the steadiest investor question their strategy, but we would expect a 50% drawdown to happen over 19 times if we played the coin-toss game 300 times as we posited earlier. Casinos Play Optimally and Pool Money to Help Reduce Likelihood of Losses While playing optimally—if emotion wasn’t part of the game—might help lead to better results, it can’t solve for the volatility in wins and losses. And yet, that’s what most players want: to win and keep on winning. Maybe you could pool your money with many other players and share your collective winnings in order to reduce your likelihood of losing… Congratulations, you just invented the casino! Positive expected returns and small bet sizing are exactly what allows a casino to reduce their risk and maximize returns, and why you see casinos impose maximum limits on bet sizes, even if the odds are in their favor. Outsmart average. Be more like the casino with your investments. When thinking of gambling, everyone wants to be James Bond—calmly going all-in on what seems like an impossible hand, and then winning with a royal flush in the end. But for each James Bond, there are thousands of gamblers losing their money in games specifically designed to be stacked against them. What’s really cool is to be the casino. Strict regulations and the astronomical amounts of cash needed to create your own casino makes it a hard business to crack in to, but what you can do is implement some of the factors that help make casinos successful into your own investment moves: 1. Diversify your bets. Casinos never bet all their cash on one horse. Similarly, you can improve your investment returns by diversifying your investments across different asset classes and geographic markets. 2. Play the odds. A casino will never enter into a bet in which they expect to lose money. Most individuals would probably say they behave the same way, and yet millions of Americans keep significant portions of their cash in checking or savings accounts with yields far below the current inflation rate, almost guaranteeing that they’ll lose money in real terms. If you don’t want to invest, help maximize your cash by putting it to work in a cash account, like Cash Reserve. 3. Turn Your Losses into Wins A small consolation if you lose at the gambling table is that your losses are tax-deductible, up to the extent of your other gambling winnings. You can do even better, however, by harvesting and deducting your investment losses, while still retaining the potential for investment upside. -
Is Financial Planning Different For Women?
Is Financial Planning Different For Women? For many women, financial planning is a daunting task that poses risk in the long term if overlooked. According to a recent study by Fidelity, women save 9.0% of their salary annually, yielding an average of 6.4% annual rate of return. In contrast, men save 8.6% of their salary annually, yielding an average of 6.0% annual rate of return. And yet, a breakdown by demographic of the average U.S. savings account balance found that households headed by men save an average of $35,000 per year, while households headed by women save an average of $17,000 per year. Median values are even more skewed: male-headed households save $9,200 per year, while female-headed households save $2,500 per year. Ultimately, women — especially women over the age of 50 — need to both proactively prepare themselves for economic disadvantages as well as unforeseen circumstances like health issues or joblessness in order to help ensure their financial stability. How wide is the gender wage gap? It’s a well-known fact that women make less than men, despite working more – as of 2018, white women make 77 cents for every dollar that men make. African American women make 61 cents on the dollar, and Hispanic women earn just 53 cents on the dollar. Wage gap aside, women also face hurdles when leaving the workplace to care for others, with 1/3 of women returning to the labor force being paid less than they were when they left. Women also tend to spend less time in the paid workforce, with the average woman working an extra unpaid 39 days a year compared to men, and spending 12 years out of the workforce to care for others. Additionally, women tend to live longer (most women expect to live for 25 years after retirement) than men, and are therefore often responsible for saving more retirement income, as well as for higher lifetime healthcare expenses. How does the wage gap impact financial planning? So, is financial planning different for women? Absolutely. These realities make retirement planning a daunting task for many women. On the plus side, recent studies have shown that women are better investors, with an outperformance of around 40BPS per year vs. men. In the same study by Fidelity in which over 8 million investment accounts were reviewed– their conclusion was that women achieved higher returns on average and were better savers from a financial planning perspective. The theory behind this phenomenon is that women around the world are responsible for the operation of the household, which mandates a longer-term view when it comes to planning for the future. These habits are reflected especially in the frequency of churn in a portfolio– men who trade tend to trade 55% more frequently than women. In essence, women tend to earn less-- though they work more-- since much unpaid labor is performed by women. The average woman will lose 12 years in the workforce due to having to take time off to care for others, and face lower wages upon returning. And yet, women will on average spend more time in retirement, which means they must save more than their male colleagues to attain the same quality of life. 3 Financial Planning Tips For Women Women shouldn’t have to suffer negative financial consequences for looking after their family or derail their retirement plans for having one. The overall lower lifetime earnings makes it critical for women, especially, to invest intelligently and make wise financial planning decisions from the very start. Aside from ongoing social forces seeking to have women’s unpaid and underpaid labor recognized and compensated, there are tangible actions that women can take to prepare for the financial realities they face. Secure access to financial advice. Financial planning is a difficult project to tackle alone- that’s why advice in this industry is so valuable. Traditionally, when finances were largely handled by men, women had little to no access to financial planning resources, or to an advisor. This clearly presents a huge obstacle to a woman’s financial independence and security, especially if the man exits the household. Thanks to the progress we’ve made in this sector over the last few decades, financial advice is now easily accessible to anyone. Learn more about what Betterment offers. Maintain a DIY financial plan. While an advisor is certainly a valuable and often necessary ally when it comes to finances, the final responsibility for our financial health still falls on us. It’s important to know where to start your financial plan in various areas of your life- for example, you would save for retirement much differently than you would save for a new car, a child’s education, or for medical expenses. There is no one-size-fits-all solution to staying on track for retirement, but Betterment can help you make better sense of the pieces you need to know. We take into account taxes, inflation, your risk appetite, investment horizons, and other personalized factors that change the way you should invest. Learn more here. Know the consequences of costly financial mistakes. Because many women don’t save enough for their own retirements and also often have the social obligation of caring for others, this can lead to an emergency need for readily available cash. Early Withdrawals From Retirement Accounts During these times, it can be very tempting to, for example, withdraw from a retirement savings account, such as a 401(k), to fund other expenses. However, actions like this could lead to negative tax consequences, and ultimately deplete the savings at a faster rate. In this instance, withdrawing money from a tax-deferred account before age 59.5 triggers a tax penalty of 10%, and regular income tax has to be paid on the entire amount of the withdrawal- essentially eroding the value of the contribution. Being aware of the caveats of early and one-time withdrawals is important, but another way you can avoid costly early distributions is to build a sizable emergency fund so that you're prepared in case anything unexpected happens, such as a medical emergency or job layoff. The Simple Truth During this Women’s History Month, it’s worth reflecting on how far women have come in taking charge of their financial futures and addressing social issues that leave them vulnerable to risk in the long term. However, despite this progress, there are still improvements to be made. By being mindful of the financial and economic gaps they face in comparison to their male counterparts, women can take the necessary steps to help prepare themselves for a successful, secure future. -
Why’d I Do That? Never Forget with the Investing Journal
Why’d I Do That? Never Forget with the Investing Journal The Investing Journal is a Betterment feature that allows customers to add personal notes to transactions. To our algorithms, your $1,000 withdrawal on May 17, 2014, is just another record in the database. But to you, it was a graduation present for your son or daughter, or cash for unexpected car repairs. The decisions and transactions you make in your Betterment account tell a story of your financial life, but until recently there was nowhere to record the color of that story. The Investing Journal is a new Betterment feature that allows customers to add personal notes to transactions. This lets you document why you made a given decision, never forget what caused it, and help you learn more about yourself. And, of course, it helps us improve our advice by understanding the needs and motivations of our customers. Record the “Why” of Your Decisions The Investing Journal allows you to annotate each withdrawal or allocation change you make in your account. Any time you complete one of those transactions, you’ll see this optional form, which you can use to record a category and any details, similar to what you might write in the “memo” field on a check. When you review your transactions on the Activity tab, you’ll see your notes along with the normal automatically generated descriptions. As we expand the feature, you will see your notes show up in more places throughout the app. By annotating your transactions with the Investing Journal, your Betterment account will become a more informative and transparent experience, reflecting your history and decisions. If you get to the end of the year and wonder how you ended up ahead of schedule or have some catching up to do, you can reference the series of decisions that got you there. You’ll never have to look at your statement at the end of the year and wonder, “Why did I withdraw $500 in February?” Learn More from Your Experience; Never Forget Why In addition to personalizing your financial experience with Betterment, recording the reasons behind your decisions is a great way to learn about yourself as a saver and investor. Seasoned investors will often cite their years of experience through business cycles and investing fads as the reason they are able to make good decisions today. It clearly helps to have witnessed moments of uncertainty and see that it turned out OK, or to have taken risks and felt the payoff. But research shows that investors often lack an accurate understanding of what has happened, and the lessons we learn can only be as good as our understanding of the facts. Our memories are not a perfect record of what happened, and psychologists have shown that the errors are not random. For example, the peak-end rule originally offered by Nobel Laureate Daniel Kahneman describes how we typically remember the most extreme and most recent events in a sequence. Applied to investing experience, this would mean that investors typically remember the most extreme periods of gains or losses as well the most recent performance of their portfolio, but mostly forget the average periods in between. The problem is that these salient memories are not a good summary of the overall experience, so using them to inform decisions about the future is risky. Another way our memory plays tricks on us is the hindsight bias, which describes how unpredictable events seem obvious in retrospect. For example, imagine a time when the market has declined 3% over the previous two weeks. It is very difficult to predict whether it will continue downward, rebound, or stay where it is. When looking back at how things turned out, however, many will be tempted to say, “I knew it all along!” Many well-designed experiments in sports, politics, and finance show that the outcome only feels inevitable after the fact. Our predictions in the moment are not nearly as good as we feel they would have been afterward. When we don’t put our predictions in writing, it’s easy to feel more prescient than we are and become overconfident as a result. For customers who make frequent ad-hoc deposits or withdrawals, the Investing Journal can help to paint a clearer picture of where all that money is coming from and where it’s going. Consider a customer reviewing the progress she has made in the last year on her house down payment goal. She might discover by reviewing her Investing Journal memos that many of the unanticipated withdrawals were for car repairs. Identifying the total impact of those expenses could lead to creating a new more appropriate “Car Repairs” goal or revising the savings rate for the downpayment goal. Using the Investing Journal to record your thoughts and feelings at the time of each investment decision is a great way to build a more accurate impression of your investing experience. What Motivates You? Help Us Offer More Personalized Advice Finally, we want to provide the most personalized advice possible to all of our customers. By asking customers to categorize the motivation for their actions (if they choose), we can differentiate between otherwise similar events. Consider one withdrawal motivated by fears about the markets and another being made to make a down payment as planned. The first is a good opportunity for us to encourage a buy-and-hold long term perspective to help maximize returns, while the second is cause for congratulations. To offer advice that matches each of our customers’ needs, we need to listen and understand their goals and motivations. The Investing Journal is a small step toward an exciting future of doing that in a much more comprehensive fashion. The Investing Journal turns a generic list of transactions into a personal history of your transactions. Recording the reasons behind each action you take helps build a more accurate understanding of your own saving and investing experience. And as we learn more about the motivations behind each customer’s actions, our data and behavioral team can continue to improve the Betterment experience.
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