Small changes over time make a big impact on your investments. That’s why it is important to get your retirement accounts, like 401k and 403bs, right. Here are 5 mistakes most people make with their investments and how to fix them.
1. Set and Forget 401k picks
At a local homebrew meeting I was chatting with a friend about solving the world’s problems when the stock market came up. At the time it was doing fantastic. He said he was super happy with his investments indicating that he picked the top 5 funds available according to their performance. He was up big time. It was 1999 and he had all tech funds.
The next 3 years his funds didn’t do so well.
Choose an allocation. An allocation is a mix of stock and bonds. For example, you might have 60% of your portfolio in stocks based funds and 40% in bond funds. The key is to pick an allocation that matches your risk tolerance and rebalance.
Why is rebalancing important?
It’s important to rebalance because you take advantage of buying low and selling high. That is the recipe to a successful retirement.
For example – if you had a 60/40 stock to bond allocation in 1999 and 60% of your portfolio was stocks in tech, at the end of the year, your 60/40 might’ve gone to 80% stocks and 20% bonds because of the strong year. While it would’ve been tempting to keep all the tech stocks, an investment plan would’ve suggested you rebalance. At that point, you would’ve sold your stocks high and bought bonds low.
2. Investing Too Risky for Your Tolerance
When markets get rough, a lot of people get scared and they jump ship. They sell their investments at exactly the wrong time – when it’s down. That’s not the whole problem. The worst part is they never get back in. Or they wait until markets have already recovered, and they get back in at the top. This is not a good strategy.
Pick an allocation that you can buy and hold when markets are bad. If you get nervous, rebalance.
When the market dropped 30% in 2020 not one of my clients called me in a panic. That’s because we picked allocations that matched their risk tolerance and we had an investment plan. I’m not saying they were happy. But when you have a plan, instead of panicking, you work the plan. I was super busy rebalancing accounts by selling bond funds and buying stock funds.
In addition, instead of fear, we saw opportunity. Many of my client rebalanced AND did Roth conversions at a big discount. For a $1 million dollar account that had $600,000 in stock funds that went to $400,000, we converted and bought $180,000 worth of Roth into equities that proceeded to double in less than 2 years. So not only did we rebalance and buy low, but we moved money into a tax free account. That’s tax alpha.
3. Not Investing Outside a Retirement Accounts
Most people have 401ks and IRAs. Some have Roths. But few have outside taxable investment accounts. This means that when there’s an emergency, or a big expense, think down payment, you might have to access your 401k for a loan, or worse, withdraw with taxes and penalty.
Invest in a joint taxable or trust account with after-tax money.
When you do Roth conversions, or want to retire at 52 instead of 60, you might need access to money that is not taxed or penalized outside of your IRAs and 401ks.
Many people don’t know that you can buy an account at a local discount brokerage company like Schwab and invest in it. You don’t get a deduction. But you also don’t pay income tax when you withdraw it. These accounts are great for paying taxes on Roth conversions and funding short and intermediate term goals. But it’s important to invest these funds in tax efficient funds or you end up paying tax on costly capital gains and dividends.
4. Paying Too High of Fees
Most people pay too much for their investments. They don’t pick index funds because they want to outperform the index. So they invest in actively managed mutual funds whose fees are between 0.6% and 0.9%, and pay advisors 1% to pick these funds. A $1 million investment in an average actively managed funds would cost from $6,000 to $9,000 in fees. Over 30 years that’s $180,000 to $270,000. Unfortunately, most actively managed funds do not perform as good as the index funds because of their fees.
Invest in low cost index funds.
Index funds are tax efficient and have extremely low fees. They range from 0.04% to 0.1%. On $1 million dollars, that means you’re only paying $400 to $1,000/yr in fund fees. Over the course of 30 years, that’s $12,000 to $30,000 in fees, a far cry from the $180,000 to $270,000 in fees for actively managed funds.
5. Not Getting Good Professional Help
This may seem contradictory to paying too high fees because you’re adding an advisor fee. So most people don’t get professional help. They do it themselves, thinking they’re saving money. Or worse, they hire an advisor, but don’t know what they’re paying them.
Done right, according to Vanguard’s Advisor Alpha study, a good advisor can add up to 3% to your overall return. On $1 million dollars, that could mean an additional $30,000. Over a 30 year retirement, that could mean an additional $900,000 in added return, be it from tax or expense savings or other benefits.
They key is to understand how the advisor gets paid. Make sure it’s completely transparent, and implement a plan.
Investing is important. If you want to get the most out of your investments, pick an allocation that isn’t too risky, and rebalance. Invest using low cost index funds, and investing outside your 401k. That way you you have money to fund short term or intermediate term goals. Maybe even hire an advisor to help you put this plan together. You’ll thank me when you need that money to make a down payment on your second home, which you can afford, because you fixed these 5 mistakes with your investments.