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How Can You Avoid Investment Mistakes?

14I am often asked “How can I make sure that I will have enough when I am ready to retire?” My answer: “avoid making mistakes”.

The first mistake people make is that they do not save enough.

You cannot invest money that you have not first saved. How much is enough? A young person starting out can save 10% and probably have enough to retire. A 25 year old saving 10% will save at least 100% of his or her income over 10 years, and twelve times their earnings at retirement time. You might have to save 20% to 30% of your income if you are age 45 and have not saved enough earlier in life. The hard part is that you probably need to spend less in order to save enough. (My trainer keeps telling me that I need to eat less if I want to lose weight. Everyone has issues….) Changing your saving habits is easier if you have a savings goal and a plan.

Chasing investment returns is a common mistake.

My daughter, Meredith, loves to shop for a good bargain. She doesn’t like to buy something that is not on sale. Many shoppers share this mindset. In direct contrast, most folks prefer to buy investments that have gone up in price and sell investments that have gone down in price.

Numerous academic studies have explored this phenomenon. My advice is that you not try to understand it. Simply recognize that investments, unlike any other products, become more popular when their prices rise and less popular when their prices decline. This is why we advocate that you rebalance your investment account every year or so. This strategy requires one to take profits on the asset class that has become expensive and put those profits into assets that have become cheap.

This mindset of chasing returns also causes people to stop saving at times when investments are going down, such as the financial crisis of 2008. Many people stopped their 401(k) deferrals or stopped saving money in their personal accounts at that time. Most of them said they didn’t see the point of putting more money into something that had declined in value 30% to 40%. Those who did continue to save saw their new purchases go up in value by 30% to 40% in a very short period of time. You should learn from this mistake and not repeat it!

Asking the markets to do your saving for you is a mistake.

Some people ask the financial markets to deliver more return than is plausible so that they do not have to save as much. Or they say, “It is worth it to me to risk losing all my money for the chance to double my money in a short time frame”. Both of these expectations are unrealistic. We live in a world today where low-yielding returns are a fact of life. Anemic bond returns of 2% are today’s reality. The out-sized stock returns of 2013 are not to be counted on moving forward.

There is an old investment maxim that says “If risky investments could be counted on for higher returns, then they would not be risky”. People recognize that some risky activities (e.g. blackjack) have low expected returns. There seems to be a mental disconnect that risky investment strategies (as often as not) produce exactly the same return as blackjacknothing!

I believe that you can reach your financial goals simply by avoiding mistakes. Save early and often, diversify, rebalance your investment account (so that you buy what is cheap and sell what is expensive), have realistic investment return expectations and avoid investments that can become worthless.

All of this is easier said than done. Give us a call if you need assistance.