The 5 Biggest Mistakes Investors Make
This will be difficult to keep it at just 5, but putting the qualifier of biggest, it should help. After 20 years in the financial planning I often find myself saying now I have seen everything, only to see something I never thought possible. Sometimes it feels like those insurance commercials with the outlandish events where cars land on their roof or a moose that destroys their RV.
1. A lack of understanding of all things financial and investments.
This is clearly the biggest problem with investors. For the most part people begin investing through their employer, either in a 401k or some other such platform. When they complete the forms, they randomly make some selections, as they have no idea what the difference between large cap value and international bonds is. They simply look at the returns of the underlying investments have made and hope they have made a good decision. They think well retirement is way far away, I really don’t have to worry too much. Then as time goes by, they just keep contributing and never really take time to learn more, or even ask questions. Once in a while, after a major market downturn they may receive a statement and see a big loss. This prompts them to make a change, or hopefully seek help, but usually not.
One lady who had just turned 63, and lost her job come to my office for help. She wanted to act right away and get her 401k rolled over. When asked why such a sense of urgency, she told me that she thinks her ex-boss was a crook and his business was failing, and she didn’t trust he wouldn’t take her 401k just to make payroll.
Wow! That took a few moments to sink in, here was a perfectly functioning adult, who was coming to the end of her working years and she had no idea how a 401k worked. She didn’t know that her ex-boss had no access to those funds and there was no way that could ever happen.
2. Relying entirely on getting their retirement through their employer
I have heard the words more times than I can possibly count. When someone askes me what I do, and I let them know that I am a financial advisor, one of the most common responses, is well I get my retirement through work.
Ugh. This not only shows a clear lack of understanding of the basics of financial planning, but it also is sad to hear. This individual will never take the time to learn about the other options he has outside of work. Many times, employer plans only allow you to invest in a pre-tax plan, which means once you retire every time you need money, you get to pay taxes. Had that same individual taken the time to meet with an advisor, he may have learned he may be able to contribute to his plan at work and a Roth IRA. He could have simply reduced what he was contributing at work and taken the same amount of money and put it in a Roth. Now when he gets into retirement he has some pre-tax money as well as some tax-free money. Which will help him control the costs of taxes in his retirement years.
3. Chasing returns
Everyone wants to earn more money. When someone is talking to their neighbor and learns that the neighbor’s” guy” got them a big rate of return last year, they just can’t help themselves. The next thing you know, they have moved their portfolio to the neighbor’s “guy”. Only to find out that the reason they got a higher rate of return was not some secret sauce the new guy has, but the new guy is simply investing in riskier investments. The simple rule of thumb, the higher the risk, the higher potential rate of return. The problem here is the word potential. See once they move to the new guy, things may go well for a year or two, but the markets do not only go up. Eventually there will be a downturn, and maybe a big downturn. It is only then that they find out exactly what the price of those higher returns are.
We onetime had a client who went through this first hand. In 2007 he was sure that his friend’s guy could make him more money. He was quiet cordial about it, he came and met with me and asked why he wasn’t making what his buddy was making. I spent the next hour explaining risk and return, and how the risks he was talking about were way outside of his financial plan, and even if he did get the higher returns, he could still face a big loss later, meaning he might not reach the goals in his plan. It is not hard to imagine what happened over the next two years. When 2008 hit, and the markets continued to crash, I got a call. He wanted to know how big his losses would have been if hadn’t moved his money. I invited him in for a meeting we went through the scenarios, and he quickly came back. Although as a result, he had to delay his retirement by 4 years. His friend became a client shortly thereafter.
4. Under estimating the impact of inflation
With people living 20, 30 or even 40 years in retirement, people often never consider planning for inflation. The best way to illustrate the impact of inflation is to think about the cost of a loaf of bread. The last loaf that I purchased was about $4. When I first began grocery shopping a loaf of bread was about $1.50, and that was about 20 years ago. That means the base line cost of living has more than doubled over the last 20 years. You can do this exercise with several common goods, things like gas and milk are great examples.
I remember one time my wife and I were having breakfast at a diner in a small town in the mountains of West Virginia, when we overheard the two older guys in the booth next to us discussing a new bar down the road. They couldn’t believe the bar was charging $5 for a beer. “How do they expect to stay in business?” One guy remarked, while the other made a comment of needing the government to give them a bigger social security raise. For us, five dollars was about the average cost beer, and thinking that without planning for inflation in retirement, I might not be able to afford a frosty glass of beer in retirement was a horrifying thought.
5. Confusing their financial advisors with money managers
This is not just investors making this mistake, often advisors themselves think they are smarter than the professional money managers on Wall Street. A financial advisor helps you define your goals, provide an assessment of risk, builds tax strategies, and yes evaluate which money managers are appropriate for pursuing your personal goals. If advisor at your local office is ever discussing investing as if he is a great stock trader, you are most likely in the wrong place. Money managers have an army of analyst, and spend their entire day making investment decisions, when to buy, when to sell, what to buy, are the questions they are asking. Your advisor is meeting with you. He clearly is not focused on the markets all day, every day.
I remember one client coming to us, he was very upset with his previous “advisor” He said when he initially started working with the advisor, the advisor told the client that if there was ever anything big happening, we would just pull him out. There for there was no real need to worry. As you may have guessed, late into 2008, not only had the advisor not “pulled him out”, but he wasn’t even returning the clients calls. Remember if your advisor was a great money manager, he would be working on Wall Street.
Bottom line, the best way to avoid these, and all the other myriad of mistakes most investors make is to find a good financial advisor, one who works with you as a fiduciary, one who starts by helping you develop a comprehensive financial plan and ask as many questions as you can. The more you know, the better you will do.