We Are Our Own Worst EnemiesSubmitted by Affiance Financial on January 2nd, 2015
There’s a reason why your financial planner keeps “nudging” you.
By Seth Meisler
When it comes to taking action, we are sometimes our own worst enemies. One of the hardest steps to take is the first one, as the following situation illustrates. I’m grateful to the family for allowing me to use this story (anonymously) so that the message can help others in similar situations. The story addresses why we recommend that assets be managed at Affiance, as well as why we try and help our clients by reminding them of what’s on their “to do” list.
A client of ours had a relative, an older gentleman, who was suffering from Alzheimer’s and had been living in a memory care nursing home. Unsurprisingly, the cost of his care was quite expensive. Over the last couple of years, the expenses for medical care were so great that he did not pay any income taxes.
This past spring, our client discussed the relative’s situation with us and I suggested to the family a significant tax savings opportunity: converting his IRA to a Roth IRA. When an IRA is converted to a Roth IRA, all the money is treated as taxable income. But in his situation, there would be no tax, due to the amount of deductions (primarily medical expenses).
So I suggested the idea to the family, and then… nothing. Nothing happened. No changes were made. Because the client’s assets were not managed by Affiance, there was nothing we could do (such as sending the client paperwork and then following up to make sure it was completed). Unfortunately, the relative suddenly passed away and the significant tax savings opportunity for his family was no longer available.
Looking back on what happened, I feel badly about the lost opportunity for the family and the inheritors of the IRA. I also wonder what I could have done differently. Although I had brought up the Roth conversion six months earlier, because of the stress of taking care of him, likely along with many other competing tasks, this was evidently a low priority for the family. Maybe I needed to have been even more of a “nudge.”
In fact, “doing nothing” is fairly common—so common that is has a name: “status-quo bias.” People tend to prefer no changes to their routine, as evidenced by such behaviors as always sitting in the same chair at the kitchen table. This phenomenon in the investment world was demonstrated by a TIAA-CREF study in the late 1980s. The study found that the median number of asset allocation changes by professors over their entire careers was precisely zero. This means that over half the professors who participated in a 401(k) plan made no changes, ever, to their retirement plans. These are the kind of biases that are apparently hard-wired into most of us.
Recently, Charlie Munger, Warren Buffet’s long-time partner, stated that successful investing requires "this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don't last very long."
Although this case may sound unusual, it is probably all too common. You may have an older relative who is receiving significant medical care and not paying any taxes, but has some IRAs. If so, I strongly urge you to talk with us or your accountant about tax-savings strategies.
The good news is that you’re reading this essay and thinking about hard-wired biases. Thus, you’re already one step ahead of most investors. Working with a financial advisor such as Affiance is the second step to improving your financial health, because one of our important roles is to help “nudge” you in the direction of taking action.
Through your connection to Affiance, you belong to a special group of people who understand that although we have our hard-wired biases, there are ways to address them. In the case of status quo bias, we can overcome our inertia and thus become more likely to reach our personal and financial goals.
Registered Representatives offering securities and advisory services through Cetera Advisor Networks LLC, full-service Broker Dealer, member FINRA, SIPC. Cetera Advisor Networks LLC and Affiance Financial are not affiliated. Advisory services also offered through Affiance Financial.
Information presented does not involve the rendering of a personalized investment and should not be viewed as an offer to buy or sell any securities discussed. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for an investor.
Tax and legal information contained in this publication is general in nature and should not be relied upon as tax or legal advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.