Lowell Herr's  Instablog

A few days I came across an article on the psychology of investing over on the Portfolioist blog. The article is written by Daniel R. Solin, author of "The Smartest Portfolio You'll Ever Own." Readers will recall that I analyzed some of the portfolios from the Solin book here on ITA Wealth Management. When I read articles of how our brains can get in the way of successful investing, I am reminded of the Dunning-Kruger Effect. Read the first few paragraphs and see if you don't agree.

Education is one of my key points to successful investing and that takes effort. While "The Golden Rule of Investing" involves the discipline of saving, education is right up there as one of the most important aspects of investing. Look over my Top Ten Investment Books and begin your investment education. Those interested in an amplified version of the Solin article will find it in Chapter 4, "The Enemy in the Mirror" of William J. Bernstein's excellent book, "The Investor's Manifesto." Fans of Bernstein know he is a strong advocate of using index funds to populate portfolios.

Saving, reading, asset allocation, discipline, patience, etc., are all about preparing for the financial aspects of retirement. I am already in that stage of life, but this blog is written for those a long way from retirement as well as for retirees. If I had my druthers, I would prefer to capture very young investors to this blog as time is crucial to successful retirement planning. Look up the Goofus and Gallant examples for further clarification.

When I gave financial talks at the school where I taught, I don't recall a lecture session where anyone in their twenties showed up. I assume they thought retirement was too far into the future. However, the lecture hall or classroom was filled with 50 and 60 year old folks - and some were in a panic as a result of not saving early in life.

In the original Sortino Ratio">Sortino Ratio where we have S = (R - T)/DR, the T equaled MAR or Minimum Acceptable Return. Sortino dropped that term for his trademark term Desired Target Return (DTR). Think of T as Retirement Target Return (RTR). The more one saves, the lower the value of T. What we need to do is construct a retirement portfolio where the R value or the Internal Rate of Return (IRR) for the portfolio exceeds the RTR. The RTR percentage depends on many factors, including life expectancy, life style, retirement contributions, pension, social security income, retirement income from other sources, inheritance, and unexpected expenses. Many of these factors are not known, particularly for those where retirement is far in the future.

Built into the Quantext Portfolio Planner is a Monte Carlo calculator to help us determine what annual saving is required in order to lower the probability of running out of money during the retirement years. From time to time I show these calculations as they are associated with the various portfolios tracked on this blog.

One of our major goals is to come up with a portfolio where the Internal Rate of Return (IRR) of the portfolio (represented by R in the Sortino Ratio equation) exceeds the T value or what one may call the Retirement Target Return. We want to accomplish this goal while keeping the portfolio risk as low as possible.