You might be walking away from a huge chunk of your retirement income for no good reason. You don’t need to make the best retirement investments, you just have to avoid the worst. Over the course of a 35-year career, the typical 401k member losses 23% of his or her retirement funds because s/he makes bad investment choices.
According to a new National Bureau of Economic Research study, you can boost your retirement income by 23% by simply avoiding a few minor mistakes. And even if you are already retired, you have a lot to gain by paying attention to this study. You’ll see why in a minute.
The Wharton School of the University of Pennsylvania team up with Vanguard Group, the mutual fund giant, to put together a group of researchers. They looked at over 1 million 401k participants at over 100 companies. They examined these people’s investment habits and results and came to some surprising conclusions.
(Of course this isn’t the first study showing how emotions create bad financial behavior, but this study was the first that looked at such a huge amount of data. As a result, it’s much more reliable.)
The researchers concluded that 401k savers underperformed by 0.11% per month when compared to a global index. That’s not much on a monthly basis, but it’s enough to lob off 23% from a retirement portfolio after 35 years.
And you know what? If your account value is 23% lower than it could be, your income is going to be reduced by 23% too – once you start tapping into it. Why did the 401k savers underperform?
There were two reasons:
1. People invested heavily in their employer’s stock.
People often load up on their own company’s shares because they feel obligated to. Other times, they can buy shares at a discount to their market price. That’s not a bad deal. In fact, it can be a great deal. When they ask, “How much money do I need to retire,” they see it’s a big number. They often get greedy and want to reach that goal quickly, so they take chances they shouldn’t.
When you have too much money in one stock for too long, you take on way too much risk. Of course, this can work out, but it can also mean disaster. (Does the name ENRON mean anything to you?)
2. People didn’t have a diversified portfolio.
The researchers found that investors kept too much money in a very narrow band of investment choices rather than spreading it around, and this hurt their performance.
OK. I’m not going to argue with the data. But if you are a regular reader of Wealth Pilgrim, you know that I’m not a huge proponent of asset allocation – (which is another way to say diversification.) So does this study prove I’m wrong?
Not really. We don’t know how the people in this study managed their money. We don’t know if they were “buy and hold” investors of if they managed their portfolios actively.
But I think it is fair to conclude that if you a passive investor, you are probably going to do much better if you diversify than if you “buy and hold” a narrow range of funds.
Another pitfall to avoid is to ignore small cap share tips – or any “hot stock tips” for that matter.
This study proves that very small improvements over a very long period of time really add up. It makes sense for all of us to pay attention to little mistakes because they add up to be big ones over time.
What use is this to you if you are retired?
Even though this study looked at people who were still actively employed, it’s actually MORE important to you if you are already retired. I say this for a few reasons:
First, if you are retired, you aren’t making contributions to your retirement account. As a result, it’s even more important to make sure that you aren’t making any small mistakes.
And even if you are already taking retirement distributions, you’re probably still a long-term investor. For example, if you are 71 and taking distributions, you might live another 27 years. (If you are interested, here’s an interesting tool you can use to project your own longevity.)
Investment Decisions Matter
For me, the takeaway is that it’s critically important to look at how you make your investment decisions. Having a retirement income that’s increased by 23% can make all the difference in the world to you.
I know it can be intimidating to learn about investing if you don’t know much about the subject. Because it’s complicated and intimidating (to some of us), we sometimes throw up our hands. And since nobody can guarantee that one approach is better than the next, it can be easy to just make a few decisions and then ignore your options over time. It’s certainly the easiest choice to make.
But as the study indicates, it’s probably the most expensive way to go.
There are plenty of free resources to help you improve your investing skills and stop losing money. Take advantage of them.
Are you happy with the way you manage your retirement funds? Do you feel intimidated by the available choices? How do you make your investment decisions?
P.S. I participated in the following carnivals last week. Please feel free to visit:
Best of Money
Money Links: Health Care Rage Editions
Festival of Frugality
Also, one of my favorite bloggers wrote a very nice piece on Warren Buffet. Check it out. Great insights provided as always.