Retirement is nice in many ways, especially when the stock market has been strong. When we’re making money with little effort, financial success can seem simple.
But important things usually aren’t quite as simple as they seem. What we don’t know and what we don’t see in fact can hurt us.
The following discussion was inspired by a recent article by my fellow Retirementor Rob Isbitts, in which he describes half a dozen mistaken assumptions that investors make.
Following his lead, I have identified four mental traps that can ruin an otherwise successful retirement. Fortunately, it’s very possible to avoid each of these traps.
1. Betting on a track record
Perhaps the most common trap is thinking that the recent past is a good guide to the future. This of course is tricky, because momentum really exists and often continues. But the financial tide can turn swiftly and unexpectedly; momentum can vanish in a heartbeat.
When shopping for a fund (the same is true when seeking a guru or an adviser), amateur investors almost always focus heavily on the fund’s track record. They believe this will tell them something meaningful about how the fund’s strategy will work in the future.
This seems totally logical. But has it worked?
This trap wrecked a lot of retirements right after the turn of this century. During the 1990s, the U.S. stock market — mostly big growth stocks represented by the Standard & Poor’s 500 Index — moved upward relentlessly, leaving almost everything else in the dust.
For a whole decade, the S&P 500 compounded at 18.2% a year, about twice its long-term average. Many people decided that investing was easy — just buy big, popular stocks, especially technology issues. Worrying about risk was regarded as something for sissies and old fogies.
Surveys in 1999 and early 2000 indicated investors expected on average to achieve returns of 20% to 30% in the next 10 years.
Recalling that history, imagine that you were an investor in January 2000 with new money to invest.
Would you jump on the bandwagon of this compelling 10-year track record and fill your portfolio with the S&P 500?
Or would you limit such stocks to just 10% of your portfolio and instead diversify into “underperforming” asset classes like international stocks, small-cap stocks and unloved value stocks?
The latter approach would have required believing in an asset mix that had about half the return of the S&P 500 for the decade just completed. But if you had done that, you were likely to prosper during the following 10 years.
If you had followed the former path, however, believing the recent past was a good guide to the near-term future, you would have been clobbered. The S&P 500 actually lost about 1% a year from 2000 through 2009, even with dividends reinvested.
Our emotions — and Wall Street’s marketing machine — may tell us that recent performance is a good guide to what’s ahead. The facts show us the opposite.
2. Picking the wrong retirement date
Anyone who has worked with retirees can describe retirements that were ruined by failure to accurately address the question of when enough really is enough.
This problem comes in two forms.
First, some people are impatient to retire. They may believe they have more than enough assets and will need only modest income. But if markets decline shortly after they retire, they may suddenly have less than enough — after they’ve already left their jobs.
In the second case, couples at peak earning years keep working long past normal retirement age, adding assets even when any outsider can see they already have enough. When they finally stop, health problems may prevent them from enjoying the retirement they envisioned.
These mistakes happen to smart, savvy people. No matter how intelligent you are, you’re probably too close to the issue to see it clearly.
3. Refusing objective help
In nearly half a century of working with investors, I’ve spent countless hours helping people figure out how much is enough. It is not an exact science.
One helpful tool is a set of tables showing hypothetical retirement distributions under various scenarios. But despite explanations, most people don’t get full value from these tools without outside help.
Still, many investors compromise their retirements by insisting that hiring an adviser is a waste of money. Ask yourself this: Can you afford the arrogance of believing there’s nothing important you don’t already understand?
An objective outsider can recognize emotional blinders that prevent you from knowing when enough is enough. A good adviser can protect you from the twin traps of fear and greed.
The 2007–2009 bear market ruined many go-it-alone retirements. Others weathered it well because they had professional guidance. In many cases, the value of that advice paid for itself many times over.
4. Putting faith in one-size-fits-all funds
The fourth trap is believing that investing is inherently easy and that a super-simple solution is best.
Too many people compromise their retirements by relying on target-date retirement funds. These one-size-fits-all solutions assume that the only thing that matters is the year you plan to retire.
But real life isn’t that simple. You wouldn’t trust a doctor who based your entire health plan only on your age. Why trust your financial future to an investment plan based solely on an assumed retirement date?
You don’t need an advanced degree or hundreds of hours of study to invest wisely. But if you oversimplify things, you risk cheating yourself out of the retirement you deserve.
Richard Buck contributed to this article.