What to do with an Investment Windfall
Investors spend a lot of time and energy talking about the next big market crash or how to avoid large losses. The opposite side of that coin is what to do when faced with large, unexpected investment gains. It’s natural to want to spend at least some of this “free money,” but before you rush out and buy something, take a few minutes to think about the advantages of not doing that.
* Performance used to calculate ending values are average rolling period returns compounded by geometrically linking monthly returns including reinvestment of dividends. Assumes no change in MSRP for the period indicated. 2021 new car MSRP provided by JD Power. Source: Fama-French Market Return Series, January 1, 1927 – December 31, 2020
Let’s assume you started a year ago with a $50,000 investment portfolio which suddenly appreciated by 50%. Your portfolio is now worth $25,000 more than you started with. What about if you bought something with that $25,000, maybe a car? To illustrate the trade-off of buying something now versus waiting, the chart above shows cars you could afford over different time periods (ignoring the impact of inflation on the future price) if you resisted the temptation to buy that brand new Kia Niro now and instead invested your money. Waiting just three years could put you into a luxurious Cadillac. Wait a decade and that convertible Porsche may be yours. And patiently waiting 20 years might turn an impulsive $25,000 purchase into a bonafide supercar.
But the cars aren’t really the point here. What matters is the cost of spending $25,000 today increases with time, by doubling in seven years and finally ballooning to nearly $200,000 over 20 years when measured against investing. Lastly, large gains in short timeframes are part of the historical gains in the stock market and are integral for offsetting losses and building long-term wealth.
From the Behavioral Viewpoint
What is going on?
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Selective Perception happens when we perceive that we have received “free money,” we tend to want to spend it because we believe there is no cost to doing so.
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Hyperbolic Discounting causes us to place more value on the present. We have a hard time making short- and long-term trade-offs and delaying gratification.
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Availability and Information Bias cause us to think we need to know what is going on in the economy and markets and act upon it. The pundits and experts are in full force opining about the post-pandemic recovery and possible outcomes. If history is any gauge, most of the predictions will prove to be wrong.
What can we do?
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Try to avoid impulse spending and buyer’s remorse. Be aware that there are costs and benefits to all decisions.
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Develop and follow a needs-based financial plan along with planned contributions and withdrawals. Review spending decisions and timing in the context of your overall goals.
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Have a disciplined investment process with a growth portfolio designed to be resilient over a wide range of market conditions.
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Tune out the noise and work with an experienced financial advisor who can help you to make wise choices and stay on track.
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IMPORTANT INFORMATION AND DISCLOSURES
The information provided here is for general informational purposes only and should not be considered an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. It should not be assumed that recommendations of AthenaInvest made herein or in the future will be profitable or will equal the past performance records of any AthenaInvest investment strategy or product. There can be no assurance that future recommendations will achieve comparable results. The author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions. AthenaInvest disclaims any responsibility to update such views. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any AthenaInvest.
You are solely responsible for determining whether any investment, investment strategy, security, or related transaction is appropriate for you based on your personal investment objectives and financial circumstances. You should consult with a qualified financial adviser, legal or tax professional regarding your specific situation. Investments involve risk and unless otherwise stated, are not guaranteed. Past performance is not indicative of future performance.
ABA-2021-06