Yahoo Finance 5 Mistakes IRA and 401(k) Investors Make
A fact of modern life is that most of us are responsible for financing our own retirement, rather than relying on a company pension. We have Social Security, which provides a baseline income. But Social Security does not pay for a middle class retirement. For that we need the savings we've built up over the years, along with the investment returns we've been able to achieve.
Despite a few hiccups, like the early 2000s and the 2008 recession, the stock and bond markets have been good to us throughout our working lives. The Dow Jones Industrial Average has risen by a factor of 20 since 1970. The problem is that most people do not reap the full benefits of the markets. Here's why you're missing out on the investment returns you could be earning.
1. We think short term instead of long term. When the news is good, the markets go up and we pile into stocks. Then suddenly American troops are headed overseas or the Federal Reserve makes a surprise announcement and people panic. Stocks plummet and we sell our holdings, often just as the markets are bottoming. Or maybe we have lost money, so we're just waiting to get back even. I recall a friend in the depths of 2009 saying he was waiting for the Dow Jones Average to get back above 10,000, and then he was getting out. The Dow crested 10,000 again in October 2009. My friend sold out. Now he's been left behind by more than 7,000 Dow points.
2. We compare our returns to the market. Even if we don't admit it, we're looking to beat the market. If our investments increase more than the averages, it makes us feel good. But what difference does it make? It's almost impossible to beat the market on a consistent basis, even for professionals, because it's almost impossible to find a legitimate edge. Unless you have the kind of uncanny mathematical mind that can predict the future, it's a waste of time to try to do better than the market. Just be in the market, with a broad-based exchange-traded fund or mutual fund. It's even worse to compare investment returns with friends. Investing for retirement in not a competitive sport. What matters is saving and investing money for your own future.
3. We don't keep our eye on the ultimate goal. Most people say, quite reasonably, that their primary goal is to save for retirement, and maybe leave an inheritance to their children. But for many people that goal is a long way off, and meanwhile we have pressing needs like buying a house, paying college tuition and taking a long-awaited vacation. It's easy to rationalize why we should suspend our savings plan, or even take a loan out from our retirement fund. But then we undermine our goal. And we're kidding ourselves if we think we can make it back by exchanging some steady mutual funds for riskier stocks. That's called gambling. And we shouldn't gamble with our retirement funds.
4. We think we're so smart. If we're smarter than average, we can invest better than average, right? Let's put aside the fact that we may not be as smart or well informed as we think, and that the insight we just had is already well known among market insiders. According to a State Street survey, alpha -- the measure of extra return due to skill rather than luck -- has been diminishing for years. In 1990 the study concluded 14 percent of equity returns were due to alpha. But by 2006, because of the spread of information and the increased sophistication of investors, alpha had declined to less than 1 percent. So even if we were prescient enough to produce some alpha, it would likely make only a tiny difference in our total returns.
5. We forget to rebalance. Rebalancing is a tried and true method to diminish risk in a portfolio. If our funds have had a good year, we take some money off the table, and thus diversify and reduce risk. We've potentially cut into even more profits if markets keep going up. But do we need additional profits more than we need to protect what we've already earned? And remember the concept of reversion to the mean. If the market gets ahead of itself, it will almost certainly take a rest, as it has in 2015, or worse, take a plunge like it did in 2008. Wouldn't you rather miss out on piling up another $50,000 in your portfolio, which will likely not impact your lifestyle in a huge way, than suffer a $50,000 loss, which might deal a severe blow to your standard of living? Or, as the old saying goes, no one ever went broke taking a profit.
Tom Sightings is the author of " You Only Retire Once" and blogs at Sightings at 60 .
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