The Psychology Of Investing – Part I

Today I’ve been thinking about an article I read a few years ago, in which the author talked about how, as the value of his investments grew, the value of his portfolio fluctuated more. It got to the stage where the daily fluctuations in the value of his portfolio would fluctuate by the equivalent of a days salary. Then as he saved more money, his portfolio would fluctuate by a weeks’ salary and then a months’ salary. As he approached retirement, his portfolio might fluctuate by a range equal to a years’ worth of salary.

There’s a few interesting things about this. I think firstly, based on a 5% ROI, if you need a year’s worth of salary as a retirement income (given that it’s normal for stocks to fluctuate by 5-10%) in order to use stocks as a retirment income, one must accept that their portfolio will fluctuate by at least a multiple or two of their annual salary each year.

To use stocks as a retirement income, you have to be OK with watching your portfolio drop in value by the equivalent of a year’s salary or more.

This is quite a mindset to get your head around. Given that other asset types probably fluctuate that much as well (you just don’t see it because you don’t know the exact value of your house or private business on any given day), you have to accept that this is pretty much the same for any retirement portfolio.

I think one take away from this point is that you have to view your retirement portfolio in a way that you don’t lose sleep watching it (this is actually one of the things I like about being a value investor, because regardless of what the current value of a stock is, you feel good that you bought at less than where you see value in the stock).

The other take away is that you need to plan your retirement portfolio in such a way that accommodates these inevitable fluctuations. This might mean having a larger portfolio than you need, in order to cover the risk. This might mean having part of your retirement income guaranteed, or perhaps diversified or hedged.

I think that to achieve the acceptance of these fluctuations, one must change how they see money. Personally I don’t see the money in the same way that I used to (which was a thing that relates to how much I’ve saved or how long it would take me to save that amount of money). I see money as a number that I can manipulate, and as a number that is measured in relation to factors such as ‘inflation’ or ‘how much money I need to fit my financial models’.

This view not only helps me feel nothing when my portfolio drops in value by $10,000, but it also helps me make better decisions that are less influenced by emotion. With that said, I’m still working on this – I don’t feel absolutely nothing if my portfolio drops by thousands of dollars, and I’m not completely emotionless. These things are somewhat linked to how well things are going to plan, but if things are going to plan and my portfolio drops by $10,000, I’m still happy.

How Can Your Portfolio Dropping By $10,000 Be Part Of Your Plan?

I just wanted to pre-empt the titular question, which I’m sure everyone is thinking after reading the last paragraph. In short, I have several plans that are constantly in some sort of flux due to perpetual changing situations (Covid19, etc.).

Basically, I have a Plan A which is to retire with funds from selling my largest private investment. I have a Plan B, which is to retire with funds from selling my second largest private investment and income from my largest investment. I have a Plan C which is to retire on my listed stock portfolio. I also have a Plan D.

There are various versions of Plan A and Plan B that involve a mix of a few things. Which is why it could be perfectly acceptable for my NZX portfolio to drop by $10,000 if Plan A or B is looking good.