In my May 7 column, I pointed out five investing mistakes you should avoid to optimize your retirement income. In this column, I’ll discuss five more.
Excessive costs. Index funds offer a return at a low cost. This is particularly true through the Thrift Savings Plan, where the cost of participating in the market’s return has been about 1/20th of 1 percent in recent years. It is not uncommon to find investors in retail brokerage accounts paying 2 percent, or more, for the privilege of investing their money. In vehicles like variable annuities and life insurance, the costs can reach 3 percent or more. These costs directly reduce the returns produced by your portfolio.
And, those costs diminish the standard of living your portfolio can safely support. Starting at age 60, for example, each 1 percent you pay in investment expenses reduces the standard of living that can be supported by your investment assets, and the expected residual value of those assets at life’s end, by about 10 percent.
When considering all of your investment expenses, you shouldn’t spend more than 1 percent per year of your invested portfolio to plan and implement the right investment program.
Poor diversification. A properly diversified portfolio hedges all types of risk at all times: You won’t be fully invested in whatever asset type produces the greatest return during any given period, but you won’t be fully invested in the worst performer, either.
If you were offered a bet on one flip of a fair coin, where “heads” rewards you with fabulous wealth but “tails” punishes you with miserable poverty, would you take the bet? A prudent investor will not, because the outcome of a loss is unacceptable. It’s not worth risking a comfortable future for a lavish one, when there is a 50 percent chance of losing everything.
This is the problem with poorly diversified portfolios. They pose too much risk for the potential gain they offer.
Misallocation of resources. If you’re going to spend time and money on investment management, where you spend them is important. It’s not unusual to find an investor using a formula invented and promoted by Wall Street: spending 1.5 percent of his portfolio value (the cost of the average managed mutual fund) trying to beat the market and another 1 percent for advice in picking the managers to do the work. In many cases, there is little or no effort to ensure the investment strategy is appropriate for the investor’s needs.
Most of your resources should be applied to analyzing your circumstances, goals, resources and constraints; handicapping the probabilities associated with markets, taxes, inflation and your longevity; and determining the investment strategy most likely to meet your needs. The smallest amount possible should be devoted to actually implementing and managing that strategy.
Misplaced trust. To be trustworthy, an adviser or manager, at a minimum, must be free from conflict of interest; competent in the skills required for the job; experienced in using those skills; and motivated to get the job done right.
Too many in the financial services business are “trusted” and far too few are “trustworthy.” Most of those presenting themselves as advisers are salespeople in disguise. Insurance agents and registered representatives of broker-dealers are simply commissioned salespeople. They are obligated to put the interests of their employers before your interests and are not legally liable to you for doing so.
Registered investment advisers, on the other hand, are licensed to accept fees directly from their clients and have a fiduciary obligation to you, as the paying client. They are held to a higher legal standard of care and are obligated to put your interests ahead of all others, including their own.
It is possible for an adviser to be both a registered investment adviser and a registered representative or agent, or all three. This contaminates the relationship, and the adviser’s trustworthiness, with conflict of interest. If you want someone to execute a stock transaction for you, call a broker. If you want to buy an insurance policy, call an agent. If you want investment advice, engage a registered investment adviser.
Confusing “might” with “probably will.” Here’s a trick to use the next time you’re exposed to an investment ad or sales pitch: Try replacing the words “may,” “could” and “might” with “probably won’t,” and see how the message changes. The fact is that if the pitch could say “probably will,” it would.
Successful retirement investing is built on predictability, not possibility. If you’re relying on what might — probably won’t — happen, rather than what probably will happen, you’re not managing to your objective. Your investment portfolio should be prudent, not speculative. It should be managed to maximize the probability of producing the returns you need to achieve your goals — no more, no less.