It’s time to go back to retirement-planning school
Reprinted courtesy of MarketWatch.com.
To read the original article click here
There’s no more denying it: Back-to-school time is here for tens of millions of students, teachers and families. Throughout the curriculum, investing classes are rare, and that’s a shame, because the difference between smart investing and not-so-smart investing can be worth millions of dollars over a lifetime.
This time, let’s look at some important things you’ll probably never learn in school. Our starting point is my favorite Warren Buffett quote:
“You only have to do a very few things right in your life so long as you don’t do too many things wrong.”
If he’s right, then it’s more important to identify and avoid the “things wrong” than to try to do everything right.
Accordingly, here are half a dozen of the things investors commonly do wrong.
1. Used to instant gratification and thinking that every day’s up or down in the market is meaningful, investors lose patience and want quick results.
Being a successful investor is a bit like planting a tree farm. For a long time, the seedlings don’t look very impressive. But after a decade or so, perhaps even with only minimal maintenance, those seedlings start to look much more important. After 40 or 50 years, you’ve really got something.
It’s obviously foolish to expect a crop of trees to mature in a few weeks, a few months, or a few years. The same is true of an investment portfolio.
2. Investors let their emotions trump their brains. Much of the “action” in the market is driven by the twin forces of fear and greed.
- Fear: This is one of the easiest ways to get in trouble quickly. If you panic in a bear market and sell after a painful loss, you have locked in that loss. And you have made sure you won’t participate in the market recovery that’s almost certain to occur sooner or later.
- Greed: On the other hand, when markets are booming, some investors just can’t stand to miss out on the profits they keep hearing about. They may abandon a reasoned long-term approach and load up on stock funds just as the feeding frenzy is at its peak. When the bubble inevitably bursts, those investors are suddenly in over their heads and have little recourse except to sell — and typically they wait to do so until they have lost much or all of their gains.
The financial media stoke these fires, for their own purposes and those of their advertisers. There is always some “expert” eager to tell you to change what you’re doing.
I subscribe to a web site that’s devoted to such predictions. Here is a sample of recent headlines, to give you a flavor of the “noise” constantly buzzing in nervous investors’ ears:
- A Rate Hike Won’t Stop This Bull Market
- Monthly Charts Show Bearish Risk For The S&P 500
- Negative Quarter In Japan, China Accompanied By Signs Of Optimism
- When I Peel Back The Onion For This REIT, It Begins To Stink
- Hawkish’ Fed Presents An Opportunity In Gold
- Gold: Will It End In Tears?
3. Investors buy financial products from commissioned salespeople. These salespeople seem to have everything figured out for you; but in truth they have spent the vast majority of their “figuring out” energy to determine how they can make money from you in a way that will seem just plausible enough that you won’t balk.
In my free e-book Get Smart or Get Screwed, I list 80 reasons investors should not work with advisors motivated by commissions. In this list you’ll see lots of ways that commissions cost much more than you think. And you’ll see that the very existence of the commission motivates salespeople to put you into products that are not in your best interest.
4. Investors choose funds with high expenses. OK, this one is so simple that I still scratch my head wondering why so many people pay unnecessarily high recurring expenses for mutual funds.
The simple part is this: Every dollar you pay in expenses is a dollar that detracts from the return your fund got from investing your money. You, not the fund, took the risk of those investments, and you should get the return.
Recurring expenses typically are higher in funds sold by commissioned salespeople (see above), adding insult to a lifetime of financial injury, and in funds with active management, which on average underperform lower-cost index funds.
The only payoff I can see from high recurring expenses is the opportunity to hope the fund manager will somehow beat the market. (See below.) That hope is so forlorn that, if there were true justice in the financial world, actively managed funds would charge their shareholders no expenses at all in order to compensate them for the risks.
5. Investors shoot themselves in the foot trying to time their entries into and exits out of the market. This is a fool’s game. At any given moment, there are so many forces acting on the market that nobody can reliably predict their short-term results.
The evidence for this is compelling, meticulously compiled and reported for more than 20 years by DALBAR. If you are skeptical of DALBAR’s research, you can turn to Morningstar, which compiles similar statistics that compare the returns of mutual funds with the returns of the funds’ shareholders. The conclusions are similar.
For example, the 30-year compound return of the S&P 500 Index through Dec. 31, 2015, was 10.4%. On average, in U.S. equity funds got returns of only 3.7%.
There are numerous reasons for this, including bad advice from financial advisors, high expenses and turnover and poor stock picking by managers. But a very large part of the loss came from ill-timed purchases and sales.
6. Investors try to beat the market, primarily by choosing individual stocks and “star” managers. I’ve written a whole book chapter on this mistake, and you’ll find a discussion of it here. If you define “the market” as the S&P 500, then it’s easy to do better.
For more than 20 years I’ve identified easily accessible asset classes that have a long history of besting the S&P 500. Investors who have put them together properly have been “beating the market” by this measure with little extra risk. For long-term investors, the results of this have been amazingly consistent.
Yet this lesson is rarely, if ever, taught in classrooms.
So there you have it, six lessons you aren’t likely to learn in school. The list, of course, could go on and on.
I have written many articles over the years about the mistakes investors make. You’ll find links to some of my favorites here.
Richard Buck contributed to this article.