PHILADELPHIA — Look around you. How do you compare?
Like the vast majority of people, you probably think you’re above average.
Although it’s impossible that the vast majority of people outshine half their peers, illusory superiority, as the phenomenon is called, is alive and well.
Take, investing for example. Many people think they can get some kind of competitive edge that will allow them to outperform the market. But studies show that the majority of investors actually underperform the market — and one reason could be that they are trying to time their investments to achieve the greatest returns. Instead, they get in and out at suboptimal times.
One group of DIY investors, however, doesn’t try to time their investments. The Bogleheads, a forum of passionate low-cost investors who espouse the philosophy of John Bogle, founder of low-cost investing firm Vanguard, is willing to accept average market returns, knowing that they’ll still pull ahead of most other investors by keeping their investing expenses low. (Click here for a summary of the Bogleheads’ investing philosophy.)
Don’t let a rotten economy spoil your goals. Use the career and money advice in The Millennial Game Plan to get and stay ahead for good.
Joel Dickson (Vanguard)
At their 12th conference in mid-October, Joel Dickson, Vanguard’s senior investment strategist and principle, talked about five "crazy" things investors do. Here are those pitfalls, along with tips for avoiding them.
1. Sloth: ‘Why Do Today What You Can Do Tomorrow?’
When it comes to long-term savings, especially retirement savings, it’s best to invest it as soon as you can, because time is key to allowing your money to grow over the long term. Also, because of the difficulty of timing the market, it’s best not to put all your money in at once, but to invest a little bit every week so that if you buy high one week, it will be offset later when the market dips and you buy low.
While you probably already knew both these tips, it turns out that many investors are doing the exact opposite. In case you hadn’t heard before, contributions to your Individual Retirement Account are capped every year, with $5,500 being the limit for tax year 2013. If you don’t contribute the full amount by December 31, however, you’re allowed to make “late” contributions from January 1, 2014 to April 15, 2014 for the previous tax year.
And, in fact, Dickson says that two-thirds of investors do exactly that. This means that the majority of investors are losing out on the gains from the year before, plus not averaging out the price at which they’re buying their investments.
If this is you: Automate your best money behaviors. For instance, if you are guilty of investing late to your IRA, put $211.54 in the account every other week, to reach a total of $5,500 by the end of the year.
2. Impatience/Impulsiveness: ‘That Grass Looks Greener.’
“Investing is one of the few places where people don’t like to buy things when they’re on sale,” Mel Lindauer, one of the moderators of the forum, told me for my story on Boglehead investing principles.
And indeed, Dickson showed evidence that people tend to buy high and sell low. Why? A mixture of impatience and impulsiveness. The end result is that they consistently underperform the very funds they are invested in, which is largely a case of getting in and out at the wrong times.
“The more specialized the investment, the bigger the gap between the investment return and the investor return,” he said, as you can see in the chart below:
How investors' returns lagged their funds' returns 1997-2012 (Vanguard)
If this is you: Create a plan around your personal goals, and stick with it, no matter what is going on in the market or in the news. Only change your investments when your life changes — i.e., when you have children or when you decide to buy a home. And if you obsess over each investment, and fret if one starts to lag a little, maybe simplify them even further so you buy, say, a target-date fund for your retirement savings — one package of investments whose components change automatically as you approach retirement. That will allow you to focus on the important thing -- whether your overall portfolio is doing well, not just one piece of it.
3. Gluttony: ‘If It’s Worth Doing A Little Bit, It’s Worth Doing A Lot.’
We’ve all heard time and again that we should diversify our investments. It’s investor-speak for “don’t put all your eggs in one basket.”
But Dickson says that of 401(k) plans held at Vanguard, 300,000 participants hold 20% of their assets in their company stock. Even worse? 70,000 participants hold 80% of their assets in their company stock.
If this is you: Buy the market, which will expose to you a sliver of a whole bunch of stocks, instead of putting you at risk of losing a huge chunk of assets if one drops, taking your portfolio with it.
4. Fear: ‘Cash Is King.’
Among new financial planning clients at Vanguard, the average cash allocation in their portfolios is 30%. “People think they’re safe in cash, but they’re losing 2% a year [to inflation] in cash,” Dickson says.
Over time, losing 2% a year on your money will shrink $100,000 today to a spending power of $81,700 in 10 years.
If this is you: While it may feel safe to “keep” your cash, remember that “keeping” it is actually just a very slow loss. Making regular, balanced, diversified investments around your goals and not trying to time the market are the best way to ensure your money keeps its value. (On a related note, here's a tip for making sure your nest egg lasts your whole retirement.)
5. Negligence: ‘The Money Will Take Care Of Itself.’
Some Vanguard accounts charge $20 per fund a year if you have less than $10,000 in your account and you get paper statements.
Dickson says that when they instituted this fee, Vanguard thought that clients would immediately opt out of getting paper statements in order to avoid that $20 annual fee.
Instead, he says, “Twenty percent of accounts had at least one fee assessed, and the average was 4.5 fees per account [over a five-year period].” If you round up to five, that’s $100 every five years — which is some very expensive paper.
Similarly, Dickson also says that the best way to plan for retirement would be to, well, plan it — meaning figure out what you’re going to do before you retire. “But 60% of people come to Vanguard for financial planning assistance when they’re already retired. Then it’s, ‘How do I deal with the resources I’ve amassed?’” he said.
If this is you: Stay on top of your finances by scheduling regular money check-ins. Do a weekly review to stay on budget, a monthly check to go over your accounts, and also mark your calendar for an annual look at your financial situation so you’re not behind in your overall game plan.
Update, Nov. 1, 12:30pm: This story has been updated to reflect that the fee for receiving paper statements in some Vanguard accounts with less than $10,000 is $20, and that the average was 4.5 fees assessed over a five-year period.
