If you spend enough time watching cable TV or reading the investing advice online, it can seem that the key to making money in the stock market is to buy the right investment, ride it higher, then sell before everyone else bails out.
Yet the science behind portfolio investing — yes, actual data, collected by actual scientists — very strongly suggests that taking those very steps greatly increases your risk of losing money. Losses compound, just like gains. Pretty soon your retirement account starts to look like a checking account instead.
There are many mistakes you can make as a retirement investor, starting with overpaying for investment advice, but let’s focus on three retirement errors investors make all the time. Just three mental errors can ravage your chances of meeting your long-term retirement investment goals.
It’s not that technical a subject, and probably you will recognize these retirement errors yourself or among your peers:
Investing without a net
Behavioral finance experts talk about “loss aversion,” the mental error we make where fear of losing money greatly overpowers our desire to make money. It’s about twice as powerful a force in our minds, and it leads to all kinds of poor decisions.
For retirement investors, loss aversion happens in large part because we feel like our retirement money is all of our money. People nearing retirement often don’t take steps to reduce debts and increase cash in ordinary savings accounts. If you think you’re one bad trade short of being broke, your fear of an investment loss naturally is magnified.
The fix: It might be obvious, but you have no business running up credit card debts and operating your financial life paycheck to paycheck. It’s crucial to save for retirement but equally important to enter retirement debt-free. Get your house in order first.
Staying in (or staying out)
Part of what drives loss aversion is the “sunk-cost fallacy.” Imagine you buy a cheap but non-refundable airplane ticket to a beach town. The weekend you travel comes up but you don’t really want to go (weather is bad, feeling sick, whatever). Then you go anyway because you don’t want to “waste” the ticket. So you have a bad weekend and waste the time instead.
Retirement investors go to both extremes on this problem, staying in investments they have come to love for past good performance or avoiding investing because they think some event is going to change conditions, such as an election or random calendar date. Either way, you can easily lose big money.
The fix: Stay invested and let rebalancing call the shots on buying and selling. Realizing gains in one investment type (say, U.S. stocks) to buy another (real estate) or vice versa is taking incremental action based on reality, rather than guesses about an unguessable future. Index funds greatly reduce the risk of becoming attached to any single stock.
Confusing information with ability
Finally, the fact that you “know” more about what’s going on doesn’t mean the information you receive is actionable. Hedge fund managers have extremely high-speed connections, literally laser-driven data, and employ loads of financial rocket scientists who gather and interpret what they think they know.
A few of those managers beat the market. As a group, however, hedge funds have done horribly, greatly underperforming the S&P 500 Index. More is not better. It’s more.
The fix: Own low-cost index funds in a risk-adjusted portfolio and find something else to do with your time. Anything else. Your retirement fund will benefit and your future, retired self will thank you.