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Watching Out for the “Recency Effect” in Investing

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One of the reasons that so many of us have trouble with investing is that, psychologically, we make mistakes and let our fears overcome our common sense. And this is a very real reason that having the guts to invest in this market is very difficult. Flexo at Consumerism Commentary has a whole list of psychological factors that can lead you to make poor investing decisions. One of these effects is the “recency effect.”

This effect is when you let what you remember last about investing influence your future. Consider yesterday’s down market (it’s slightly higher today). Or the market in general, or the financial news. Here is what Flexo says about the damage that can be done when you cave to the recency effect:

In the midst of a recession, it seems like the stock market keeps getting lower. All we see is bad news like financial scandals and corruption. We forget that over the long term, the stock market has been the best way to grow your money. So we abandon the stock market and miss out on those gains when the economy rebounds.

If you opened your retirement account statement and saw a huge drop, chances are that had a big impact on you. And for the next three to six months (depending on how often you receive a statement), that’s all you think about. And the recency effect impacts you and you start thinking that you need to fix that last thing that just happened with your retirement account. Or you think that since your retirement was down this last time, it will be down forever.

It sounds irrational as you read it, but in the heat of the moment, when you have to make a decision, the recency effect becomes very real, and you might be influenced by it. Instead, it is a good idea to do what you can to avoid making decisions quickly, and carefully look over your situation and make an investing plan that is likely to last long term.


Disclaimer: I am not an investment professional. Nothing in this piece or on this Web site should be construed as investment advice. Before making investment decisions, do your own research and/or consult with an investment professional. All investment comes with the risk of loss. You are responsible for your own investment decisions and any loss that may result from your decisions.

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Retirement Investing: SEP-IRA

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One of the issues plaguing many self-employed folks is how to take advantage of retirement investing without an employer’s plan to make use of. The good news is that there are options for the self-employed to invest in their future. An IRA or a Roth IRA is an option, but there is also a type of retirement investment account for the self-employed called a SEP-IRA.

SEP-IRA

A SEP-IRA is a “Simplified Employee Pension”. Only employers can contribute to a SEP-IRA, and they do it on behalf of their employees. If you are a sole proprietorship, or a very small business (I am an LLC), you can use the SEP-IRA to ideally make contributions on your own behalf. This can be helpful, since it can result in larger contributions than if you have a traditional or Roth IRA. With the SEP-IRA, your contribution limit is the lesser of $49,000 or 25% of the employee’s compensation. (If you are doing it for yourself as a self-employed business owner, your compensation is your earned income.)

When you make a contribution to a SEP-IRA, it is not included in employee income at the time of the contribution, and it is deducted from the employer’s income. Which can be helpful if you are a self-employed business owner. Note that SEP-IRAs follow the same withdrawal rules as a traditional IRA — a SEP plan will not work as a Roth IRA.

My Dollar Plan offer this helpful insight into the pros and cons of the SEP-IRA:

SEP-IRA Pros

Sole proprietors or employers with just a few employees love SEP-IRAs because they are easy to establish and require little effort from year to year. The ability to choose whether or not to make contributions is also ideal for business owners with highly variable income from year to year. Finally, the late contribution deadline makes it easy to use a SEP-IRA to lower your tax bill after you calculate it.

SEP-IRA Cons

Because a SEP-IRA requires contributions to all employees, it is not a good plan for someone with employees who only wants to beef up his or her own retirement savings. It is also not good for businesses with employees that want to be able to contribute to their own accounts. Finally, the SEP-IRA may not maximize savings opportunities for business owners because of the way self-employment income is treated.

It is important that you invest in your future with a retirement account, even if you are self-employed. This is just one of the options that you can consider.

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You CAN Survive a Stock Market Crash

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Even though things have been a bit volatile on the stock market, that’s no reason to give into fear. Instead, consider that cycles are common. There are periods of growth and recession in the economy, and there are ups and downs on the stock market. Over time, though, the bumps smooth out and gains are to be head. While it is possible that the long term market (20-25 years) could lose, it hasn’t happened yet. When a stock market crash comes, it is important to take a deep breath and try to analyze the situation in as calm a manner as possible.

First of all, it is important to look over what you have. If the fundamentals of your investments haven’t changed, there is very little that you need to change. For stocks, you should consider that they are likely to gain in the future, and that right now, sticking with your investment plan, you can get them “on sale.”

Another thing you should do is continue to fund your retirement accounts. Jeff Rose, CFP, points this out in Good Financial Cents:

Just because I’m suggesting to fund your retirement accounts doesn’t mean you have to put in all in the market.  You will want to at least fund your retirement accounts to either get the 401k match or the tax free savings of the Roth.  Even if it’s invested into bonds right now, you’ll be able to transition to stocks later on when you feel more comfortable.

Rose also suggests diversification. You want to make sure that you are appropriately diversified in your investments, and that you have additional asset classes beyond stocks and bonds that can help protect your portfolio against huge losses — and help it recover faster.

In the end, it’s all about a measured approach. Review your investment plan, and determine whether, in essentials, it is still sound. If it is, continue business as usual until the economy and the market recover.


Disclaimer: I am not an investment professional. Nothing in this piece or on this Web site should be construed as investment advice. Before making investment decisions, do your own research and/or consult with an investment professional. All investment comes with the risk of loss. You are responsible for your own investment decisions and any loss that may result from your decisions.

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