I knew the lights were working on my hybrid car when each of the trouble indicators illuminated and the headlamps lit up even before I turned them on. I am about as mechanical as Putin is diplomatic, so given that the lights were on, I concluded engine trouble. When the guy from AAA came to tow my car, he asked if he could try jumping it first. I humored him by allowing it. And it was a dead battery. Chalk it up to misdiagnosis.
In financial planning, we deal with misdiagnoses regularly. Rather than accepting the ambiguity inherent in a complex world, we tend to try to control things. Here are some reasons why blunders occur.
When confronted with a variety of ever-changing variables, it is easy to focus on too small of an issue. One of our clients was determined to leave Minnesota because they were sick of the high income taxes. They concluded taxes were the problem that needed to be solved and, given that diagnosis, leaving the state was a fair remedy. But the problem was that they liked living in Minnesota; had strong ties here, and had not adequately researched another area that could offer as much. Taxes are a cost — like housing expenses, groceries and entertainment. Changing neighborhoods can be difficult; changing states can be dramatic. They needed to solve their whole picture of retirement. Cash flow, geography, quality of life, all are considerations in this broader question.
Another misdiagnosis occurs when people look at the wrong things. Young people need to be concentrating on how much they are saving and maximizing the benefit plans available to them. They should invest in their retirement plans aggressively, because while they are building assets, their contributions will probably have a far greater impact on their portfolios than annual returns. Returns won’t bail out an investor who fails to save enough.
On the other hand, people close to living off their investments need to manage the returns and the risks of their portfolios more carefully, because returns tend to dwarf contributions as you build up assets.
Misdiagnosis also happens when people forget why they are invested in the first place. When a client has enough money in their 529 to pay for college, why should they take on incremental market risk? Once the goal has been met, don’t move the goalposts.
We constantly see misdiagnosis in our client family meetings. “When you’re deciding whether to motivate someone, you should first think about whether your incentive might crowd out the willingness to perform well without an incentive,” writes Uri Gneezy and John List in their book “The Why Axis: Hidden Motives and the Undiscovered Economics of Everyday Life.”
Clients often ask whether they should pay their children for household chores or good grades. Chores are a part of being a family; extra things may deserve payment. If you want to pay for grades, consider a program where the money goes into a college spending account for the kids — this teaches delayed gratification and doesn’t detract from a sense of accomplishment.
In order to get the diagnosis correct, you have to first correctly identify the problem. Sometimes, our own limitations are the real problem.
Spend your life wisely.
Ross Levin is the founding principal of Accredited Investors Inc. in Edina. His Gains & Losses column appears on the last Sunday of the month. His e-mail is firstname.lastname@example.org.