In the wake of the Great Recession, being a little wary of Wall Street is understandable. But it shouldn’t keep you from investing in the stock market. In fact, not investing means you may be missing out on one of the greatest instruments for wealth-building out there.
But steering clear of stocks is just one of the potentially costly mistakes new investors make. Here are seven others, and how you can avoid them.
1. Not Investing Enough
Maybe you’re sold on the power of investing, and you know that starting early is key. So you’re in, but only a couple toes are wet. When you signed up for your 401(k) at work, you followed conventional wisdom and elected to save just enough to receive your company match, or went along with whatever the default percentage was.
If you did, you certainly aren’t alone. A study last year by T. Rowe Price found that about 63 percent of automatically enrolled employees elected to contribute 3 percent of their salary or less, and nearly a quarter said their default contribution rate was just 1 percent. The problem? That’s way below the level most financial planners recommend you contribute in order to have enough to live on when you decide to stop working.
Their advice: Start working your way up to saving 10 percent of your salary. While that may sound like a lot, remember, retirement contributions often come out of your check before taxes are taken out, so it will feel more like a 6 or 7 percent difference in your paycheck. (You don’t pay taxes on the money in your 401(k) account until you start making withdrawals in retirement, when your tax bracket is likely to be lower. Just don’t take any of that money out before you’re 59½ years old or you will have to pay taxes plus a 10-percent early withdrawal penalty.)
2. Not Risking Enough
You’ve probably done at least one of these at some point in your life: dyed your hair, sung karaoke songs on stage, told someone you loved him (or her) or gone after a big job you wanted.
In other words: you’ve taken risks in your life. But when it comes to investments, you may be behaving the opposite way.
In a UBS survey, far more millennials between 18 and 34 years old (43 percent) said they were willing to take investing risks post-crash than Gen Xers (21 percent) or Boomers (12 percent). However, their average cash holdings (41 percent) are double Baby Boomers, which is precisely the reverse of risky.
Sure, cash may seem like the ultimate safe investment. But the fact is: Money left under the mattress—or in a savings account earning 0.55 percent a year (the current average)—could actually lose value because of inflation, the rate at which the general level of prices for goods and services in the U.S. is rising. So the longer you sit on it, the worse off you’ll be.
3. Not Asking for Help
According to a Capital One Investing survey, 87 percent of young investors say they trust themselves to make investment decisions. But only 15 percent of millennials told UBS that they’re happy with their portfolios, which suggests a disconnect.
Smart investors realize that many people offering financial advice stand to profit via commissions or other fees, but that doesn’t mean all advice is bad or wrong.
Just like personal training or nutrition counseling, it’s certainly possible to make progress on your own. But plenty of people benefit from paying a professional for guidance or at least picking up a book (or reading—ahem—a personal finance site), particularly if it helps you get started and stay on track.
4. Trying to Time the Market
Another good reason that trust-in-self might be misplaced? Inexperienced investors routinely violate a cardinal rule: Don’t time the markets.
While “timing is everything” might be a decent life mantra, it couldn’t be more wrong here. Mere mortals can’t “time the markets”—or pick the exact point at which to buy and sell stocks to optimize returns—because markets move too quickly. Investors who try are just as likely to do it wrong—that is, to panic-sell when things are falling or panic-buy when things are soaring.
In the UBS survey, more than half of millennials said they regretted “selling investments at an inopportune time.” And nearly seven in 10 said they regretted not investing more in the stock market as it was recovering after the recession.
What’s a better strategy than trying (and, often, failing) to time the market? Sticking to a diversified, long-term investment plan.
5. Setting It and Forgetting It
Here’s a recipe for disaster: You sign up for your first company retirement plan, select some mutual funds, then don’t make changes for years. Why is that bad? Because you risk letting market fluctuations dictate the makeup of your portfolio and after awhile, you could end up with a breakdown of stocks and bonds that doesn’t serve your goals (such as too many or too few stocks).
So check up on your choices at least once a year, and decide if you want to stick with the current mix or make some changes.
6. Misunderstanding Diversification
You’ve heard about the value of diversification and not putting all your eggs in one basket. So you pick four or five mutual funds, then when the market drops, so do all your funds. What’s going on here?
Even relatively savvy investors may make this mistake, and newbies almost always do. The fact is, stock funds often contain the same, or very similar, investments. Look up the holdings within your funds, and you’re likely to find the top 10 all include Apple, Microsoft and GE. Translation: Your “diversification” wasn’t diversification at all.
Every investment portfolio needs real diversity. For stock allocation, that means investments in the U.S. and abroad, in large, medium and small companies, and in fast-growing and more-established firms. So take a look at the kinds of companies that are held in the funds you’re interested in before you put your money into them. (Many funds will actually indicate their makeup in their name—the Vanguard “Large-Cap” Exchange-Traded Fund invests in large U.S. companies, for example, while the FMI International Fund invests mostly in large companies outside the U.S.)
7. Ignoring Fees
Many investors, young and old, don’t understand the huge impact that fees can have on their money over the long run. Disguised with names like “expense ratio,” a fee of 1 or 2 percent may seem small, but they add up quickly. High-cost funds can easily eat up one-third or more of the money you should have set aside by age 65.
March 16, 2016