Risk vs. return: where are you comfortable?
One of the most fascinating aspects of our role as an advisor of business retirement plan benefits is the chance to meet with many different investors and participants. When we each invest, every person has a different definition of the risk they are comfortable with. Some individuals are okay with market volatility and buy and sell without a second thought. Others can’t bear to look at their statements or watch CNBC when markets are falling.
Over the last 30 years, much of corporate America has moved from defined benefit plans (pensions) to defined contribution plans (such as 401(k)s, 403(b)s, and 457 plans) for their employees. Our success in these types of retirement vehicles are reliant on our understanding of risk and returns, while making sure we are diversified. Over the years, we have seen many common investment mistakes in retirement accounts.
Following a Coworker’s Investment Allocations
One of the most common retirement mistakes we have seen is when a participant asks a colleague ‘What is your investment allocation?’ This often results in copying their coworker’s allocation.
Unfortunately, investments and portfolio structure within global markets aren’t a core part of our educational curriculum. Because of this, our coworkers are who we often look to for advice on setting up our retirement account allocations. When trying to choose the right allocation, most of us feel our eyes glaze over. We don’t know the right choices to make, so we often either do nothing and leave any automated asset allocations in place or copy someone else without considering if their situation is an exact match for ours.
This can be complicated by seeing a good stock market and hearing someone talk about how well their retirement account looks. We often ask what accounts they are invested in and will follow suit. While this may sound like a good idea, it’s still operating without paying attention to your personal situation and relevant risk levels.
For example: George is not sure of what to do with his 401(k) investments, but he hears John gained 20 percent in his retirement accounts last year. He thinks to himself: John gained 20 percent – and I would like to make that amount, too! So, I am going to copy what John did.
An example like that is all too common when we set up our allocation in retirement accounts. The major issue is George does not consider John’s risk level, time horizon, and how often his investment might change. It’s also possible George may not know a lot about the complex world of investing and economics and may not have the best approach. George is only focused on return, and this could have a negative impact, especially when markets start to correct.
Duplicating Our Family’s Investments
Another retirement mistake is selecting the same investments that a family member selects.
Once, we met with an individual who was in his early 20s, but after looking at his statement, he had an allocation that was aligned with what someone in their late 50s might have. We asked him why he selected the fund he did, and his response was “My dad said it was a good investment and since it was good for him, I figured it was good for me, too.” This type of practice is more common than you might think.
To help avoid this mistake, target date funds are a popular choice, and make sense for many participants. A target date fund is an age-based retirement investment that helps you take more risk early in your career and adjusts to be more conservative over time. For many retirement plans out there, target date funds are the default choice because they help create appropriate scenarios when we’re faced with paralysis in selecting fund types.
Timing the Market
Another common retirement mistake we often see is when someone tries to time the market. Markets can sometimes be irrational and volatility can feel like it will last forever.
There are often two courses of action when markets start to act up: you can either do something – make changes or trades – or you can do nothing and leave your portfolio as-is. For most investors, the best course of action is to do nothing and ride out the storm.
Sadly, many participants do not follow this best practice and often try to time the market. Timing the market is very difficult and even the professionals on Wall Street often are not successful. When markets start to fall when you are trying to time your results, the situation can become very scary. It is not fun to see your portfolio down by a large percentage.
We often hear stories from individuals who predicted the financial crisis and transferred all their investments to cash. The unfortunate part of their stories is they stayed in cash and took years to get back into the market. Those type of scenarios are more common, and participants miss out on participating on the upside when the markets rebound.
When markets get choppy, one bit of advice we tell individuals is to do nothing for a few weeks. If they still feel the same way as they do the first day it started feeling uncomfortable, then they can do what they were planning to do that first day. Often, the client has settled and doesn’t feel as strongly about taking an action in a panic. This is a way to avoid emotional investing and instead, develop a plan for your investments that you can see act out over a long period of time.
Follow a Solid Path
If you or a close connection have found yourself making any of these retirement account mistakes – you’re not alone! It’s hard to know what to do with funds and allocations when it’s not something you’re trained in. Therefore, it can be helpful to seek out the advice of a professional to better understand what funds may be the best fit for your life path and goals. Then, you can feel confident in making smart choices for your financial future! If you’d like to start a conversation anytime, please get in touch with one of our wealth advisors or call 855-855-5455 or email [email protected].