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How Much Money Is Enough Now?

If no pain, no gain were as effective a strategy in the stock market as it is in the gym, you'd be rich. Unfortunately, it doesn't work that way. But embedded in the agony of the downturn is a lesson that, if you'll forgive the cliché, could turn out to be more valuable than money.

“People need two things to change their habits,” says Zvi Bodie, Ph.D., professor of management at Boston University and author of Worry-Free Investing: A Safe Approach to Achieving Your Lifetime Financial Goals. “One is desperation, which many people have. The other is a way out.”

Investors have found the exit, but not an exit from investing, just an exit from a collective myopia about risk in their financial lives. In the wake of the crash, Americans have higher savings rates, an intense distrust of financial institutions, and there is anecdotal evidence of two healthy changes: a more honest evaluation of risk tolerance, and a shift toward the fiduciary standard with financial advisors.

It’s not clear yet whether these shifts represent a transformative, cultural change or just a temporary pullback while we lick our wounds. But it’s abundantly clear that this is a rare opportunity to get your own house in order. If your neighbor wants to buy Chinese Internet stocks on margin, well, he can’t say no one warned him. A lot of folks have realized that investing is not done on a green felt table with chips. It’s done with the dollars that represent the fruits of your life’s work and peace of mind about your future. You need to think harder than you once did before putting them at risk.

Life Planning

There has always been a vocal minority of financial experts who advocate a lower risk approach to investing — Bodie is one. John Bogle, founder of Vanguard, has long railed against speculative and complex investments, and more recently published Enough, a jeremiad against the greed and speculation that, as his book was published, was starting to bring down Wall Street. Another is George Kinder, founder of the Kinder Institute, who has moved the investing world in a smarter direction by replacing the concept of financial planning with “life planning.”

By first figuring out what you want out of life, you can then design a financial plan to get there. Think for a moment about that idea, and you realize that the traditional max-out-your-401(k)-with-stocks approach is really the tail wagging the dog. Once you know what you need, take the least risky approach to getting there. You’ll sleep better at night, and be just as happy when you retire.

Bogle’s book takes its title from a story he heard about two authors, Kurt Vonnegut and Joseph Heller, in conversation at a party. Vonnegut tells Heller that “their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch 22 over its whole history. Heller responds, ‘Yes, but I have something he will never have ... enough.’”

Yet these sober voices have always been drowned out by the cacophony of the Wall Street machine, which promoted adrenalized trading — cheap trades! transactions guaranteed in 30 seconds! — and the legions of financial experts and advisers who sold everyone on the historic no-lose model that was stock investing. Stocks are the best long-term investment, they said, and history bore them out.

Bodie calls those claims a “big, fat lie.” Here’s why: No matter how glorious the past numbers, “history” is all about context. Ask the boomers whose retirement accounts have been vivisected if they feel like history is on their side. Stocks, for the long run, works well on paper, but it leaves investors at the mercy of the calendar.

Kinder says he recently met a 70-year-old woman who was 100 percent in high-risk investments in 2008. In less than a year, 90 percent of her net worth was wiped off the screen. “I ask myself, ‘how on earth can that possibly happen?’” says Kinder, who is suddenly popular again as burned investors warm to his ideas. “But it has happened.”

The fallout is an obvious — and well-deserved — evaporation of trust in financial institutions: The Chicago Booth/Kellogg School Financial Trust Index — a quarterly survey of ordinary folks established in December 2008 by finance professors at Northwestern University and the University of Chicago — shows abysmal trust scores across the board for everything from brokers and bankers to large corporations and the government. A rating of 1 indicates no trust whatsoever, and a 5 is complete trust. As of the most recent data, brokers rate a 2.26; large corporations a 2.28; and bankers a 2.8. Meanwhile, our trust rating in “other people” sits at 3.33. In other words, we trust a stranger on the street 32 percent more than we do a broker.

Paola Sapienza, Ph.D., co-creator of the index, cites the impersonal service of big lenders, continued concerns with executive compensation and bonuses, and an overall lack of any kind of olive branch extended from Wall Street to Main Street. “Part of our survey for this Index is asking people, ‘Are you still angry?’” says Sapienza. “People are still very angry.”

Your Best Interest?

Given the anger, you’d think investors would dump their broker for advisers who are legally required to act in the client’s best interest, so-called fiduciaries. There is some anecdotal evidence of a migration. Neil Goldberg, a principal with Boston-based investment advisory firm GW & Wade, says he sees this shift every day as he handles business development for his firm across the country. “People want someone on their side of the table, or at least have the fee structure of their account reflect that common interest,” he says. “There’s less product, less bank-and-broker commission business. That’s true in Boston, California, Chicago — with any people in the industry I talk to.”

Kinder points out, however, that while consumers may be changing, there’s little evidence of a shift in bank or brokerage behavior. “The independent financial advisory community is adopting the fiduciary standard and is way ahead on this, but the bigger institutions haven’t budged,” he says. “We have three behemoth banks, who we [taxpayers] sent a lot of money to, who should be leading the charge on this, but in reality they should all still have signs hanging on their doors saying ‘buyer beware.’”

The Obama administration has proposed holding all brokers who give advice to the fiduciary standard, but it’s unclear if the idea will become law — or how much it might get watered down first. “There’s a conversation right now in Washington about the standard and who should be held to it,” says Kinder. And he thinks that most major institutions — if they want to hold onto customers — will eventually have to stand up and say, “We now have the consumer’s best interests in mind.” If the right company markets it the right way, Kinder believes the fiduciary standard will “sweep through the country like Starbucks did.” If so, the Great Recession will have spawned at least one change for the better.

Reducing Your Risk

“I think all of us, financial advisers and clients alike, have had a good opportunity to re-evaluate our risk tolerance,” says Frank Armstrong, founder of Investor Solutions in Florida and author of Save Your Retirement: What to Do if You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown. “The average person has been willing to say to themselves, ‘My investment strategy has been faulty, I took too much risk, or not enough risk, or some other problem that I now need to correct.’”

Michael Doshier, Vice President of Fidelity’s Workplace Investing Group, says that 33 percent of 401(k) users had a “healthy” equity allocation — defined as within plus or minus 10 percent of the allocation they’d get in their age-appropriate lifecycle fund, where risk drops with age — as of the end of the second quarter ’09. While it’s a fairly dismal statistic when you consider that two-thirds of retirement accounts are out of whack, it’s an improvement over 2004, when just 20 percent of accounts met Fidelity’s definition of healthy. “The trendline is definitely in the right direction,” Doshier says.

Redefine Your Own Investment Strategy

The jury is still out as to whether these sober voices represent a new paradigm or just a brief interruption until the party starts again. Whatever happens, this is your chance to make the right moves. These three simple steps will help you get started:

Decide, once and for all, how much is “enough.” Bogle’s book poses the thesis that most of us don’t know what “enough” is, because we have never defined what we really want for ourselves. Kinder has trained his investment advisers to have that conversation with clients up-front. “We’ve always tried to find out what clients really, truly want out of life, and their investments should serve that,” he says. “Some people don’t know what they want. It requires effort on their part to figure it out but, when things go bad, people tend to finally do the right thing. A lot of people are now willing to make that effort.”

He finds that clients who do this develop a new vitality and efficiency in how they handle money, because “they’re pursuing and accomplishing exactly what they want,” he says.

Tune out the noise. If you are honest about what you want from your money, you can finally be realistic about how much risk you should take. But to reach these levels of self-awareness, says Bodie, you have to tune out the Wall Street machine. “A lot of folks can’t afford the downside [of stocks], yet we’re all still being told that we can’t afford not to take the risk,” says Bodie. “It’s just asinine.” Brokers perpetuate the high-risk argument because they can’t make any money on safer, low-risk, passive investments, so why would they recommend them to clients? Bodie recommends that everyone have at least a portion of their portfolio in low-risk, inflation-protected Treasury bonds. “Very few people in the United States know that the Treasury issues inflation-protected bonds like TIPS and I-bonds,” he says. “Brokers don’t want you to know. You don’t even have to pay a commission. Just go to Treasury Direct or go through the Vanguard TIPS Fund.”

Never invest your lunch money. Bodie can fairly be described as radically risk-averse. His advice is that if you must approach higher-risk investments, “never invest your lunch money,” he says. “If you can afford to lose it, by all means take a flier,” he says. “But it is a lottery. There is so much in the market that is out of your control.” Taken literally, such advice flies in the face of what even a conservative planner would advise, that you keep some equity exposure to keep pace with inflation. One way to look at it: If you’re 40, your 401(k) won’t be lunch money for two, three, maybe even four decades. You can afford to take those paper losses as long as you have the stomach for it. But if you’re 63, your portfolio may not have time to recover from a bear market, so you really are betting the farm. Take those chips off the table.

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