One of the fundamental limitations of investing is that gains and losses are unequal in terms of impact. A 50% loss over just one or two years will require five years of 15% to 20% returns just to get back to where you were when you started! Translation: investment mistakes need to be avoided! This is especially true when it comes to retirement investing.
Don’t Make These 10 Retirement Investing Mistakes
A comfortable retirement will take far more money than most people assume it will, and one of the best ways to reach your goal successfully is by avoiding mistakes. Here are ten common retirement investment mistakes:
1. Investing too much at market tops
This is really about emotional control more than anything else, and that’s a critical factor when the topic is investments. One of the biggest mistakes investors make is following the crowd loading up on stocks (or any other investments) at or near market tops. Though it feels like “the thing to do”, when investors do this they’re often setting themselves up for a bigger fall than necessary when the market slides.
2. Investing too little at market bottoms
After a big sell off the masses in the investment world get spooked and stay out of the market fearing even worse to come. But this is actually the perfect time to begin moving back in, if only in select positions. Overall, you should be more buying more after market sell offs than at other times. Is there risk in doing this? Sure, but paradoxically stocks are less risky when purchased after a sell off than at a market top.
3. Inadequate diversification
It’s natural to “go with the winners”, but given the long term nature of retirement investing, diversification can never be ignored. Remember, you’re playing the averages not the bounces. No matter how well stocks are doing, never underestimate the importance of having solid asset allocations in both cash and bonds. You never know when market dynamics will shift and that’s the whole purpose of diversification in the first place.
4. Failing to maximize retirement contributions
Few people will invest their way to retirement wealth—a solid plan is based both on steady contributions plus investment returns. The more you can contribute, the less you’ll need to chase high returns (see below). Make sure you are always maxing out your retirement contributions if possible. It’s always best if this can be done early in your retirement planning, since doing so maximizes the compounding of investment returns over the longest possible time. The more money you can build up early, the easier it will be to invest later and especially as you get closer to retirement.
5. Taking on excessive risk
Investors often take on excessive risk in an attempt to reach retirement goals but that can have the opposite effect. If you’re chasing 20% returns in a 10% market you could be setting yourself up for a 50% loss. Think of retirement investing as patient capital—you’re investing for the long haul where slow and steady wins the race. Minimizing losses should get equal emphasis with investment gains. (Going without diversification is very risky. Avoid retirement ruins by diversifying.)
6. Investing in assets you know nothing about
This is closely related to taking on excessive risk. In an effort to get above average returns an investor might sink money into exotic investments they know nothing about. Junk bonds and gold stocks work for people who have knowledge of those investments (or they might not) but they’re not for the average investor. If you don’t know what it is you’re putting your money into then you’re not investing, you’re speculating. And that’s not something you want to do with something as important to your future survival as a retirement plan.
7. Failing to rebalance your portfolio at least annually
When you invest for retirement you’re managing a portfolio, and as strong as the temptation is to go on automatic pilot, it won’t work long term. Periodically—at least annually—you should rebalance your portfolio to make sure you have the right mix of stocks, bonds and cash.
8. Falling in love with an investment
You’ll be building and managing your retirement portfolio for decades; it’s unlikely that any single investment you own will continue performing over that time span, no matter how much you like it. Stocks, in particular, go through cycles of growth, maturation and decline—it’s important to recognize the shifts before it’s too late.
9. Withdrawing funds prematurely
One of the biggest investment mistakes people make when it comes to retirement investing is by withdrawing funds prematurely. That not only has the affect of reducing your retirement investment, but it often does so at the worst possible times. Job losses usually happen when investment markets are down, and that means you’ll be selling at the bottom in order to raise cash. The best way to avoid this is by maintaining adequate liquidity outside of your retirement plan, and that means a large emergency fund invested only in the safest and most liquid instruments. Think of your assets outside your retirement plans as insulation that will protect your investments from short term cash needs.
10. Underestimating how long you’ll live in retirement
Building up a retirement investment portfolio should never be a random accumulation of capital in the hope that it will be sufficient to fund your retirement. You need to start with the end in mind. That starts with a reasonable estimate of how long you’re likely to live in retirement—without knowing that number, any dollar amount chosen as an investment target may be little more than a wild guess. If you expect to retire at age 65, you should probably plan for at least 25 and more likely 30 years. If you plan on an early retirement, adjust accordingly. It’s always better to be overfunded than underfunded. Retirement investing isn’t just about having a winning strategy. Avoiding mistakes is equally important and can make the difference between the comfortable retirement of your dreams and a retirement filled with uncertainty.
Photo by jon jordan via Flickr