Common Investment Mistakes Before and After Retirement

By Christopher L. Hudson, CIMA

As the airwaves are filled with talk of inflation, higher interest rates, a difficult market and the potential for recession, let’s review some of the most common investment mistakes we have seen employees make in their 401(k) plan, while they are still working, as well as in their IRA and retirement accounts after they have transitioned into retirement.

Let’s start with some common 401(k) mistakes:

1. Lack of a financial game plan. Many times, especially with younger employees, their 401(k) retirement portfolio is a random combination of “stuff” – with no real rhyme or reason for why they own the particular investments that they do - or – more importantly – how that combination or “mix” of investments is helping them achieve their ultimate goal (being able to retire on their own terms when they decide to transition). Many employees under the age of 60 feel that there is no real need for a comprehensive retirement financial plan, or asset allocation strategy, as they are still 10, 12 or even 15 years away from actually “retiring”. But having a written game plan, or strategy, for what their retirement portfolio needs to look like in order to achieve their goals and be able to weather the storm of a bad market has no age requirement. In our opinion, it is impossible to determine the rate of return you will need to achieve on your investments, the amount of growth and income that you will need to generate along the way and the amount of “risk” that you have to take in the portfolio (the percentage of the portfolio that needs to be invested in the stock market versus more conservative options within the plan) without sitting down and mapping out a game plan for when you want to retire, how much income you will need in retirement, when Social Security will supplement your income needs and any special needs or situation that you may encounter along the way. As cliché’ as it may sound “It is very difficult to successfully reach your destination without following some type of a road map to get you there efficiently”.
2. Too much money invested in company stock: Let’s face it, many employees are most familiar with, and therefore usually most comfortable with, the company that they work for. Especially when their career has spanned 20, 25 or even 30 years at the same company. That company has provided them with a job, a paycheck, retirement savings and benefits so it certainly makes sense to feel a sense of loyalty and that the company is very well positioned for the future. Keeping too much of your retirement portfolio invested in company stock though can certainly have an impact on your overall return, portfolio balance, diversification and level of risk. Always try to maintain a broadly diversified portfolio with the proper balance of different types of investments and asset classes.
3. Investing through the rear view mirror: A common practice in choosing 401(k) investments is simply to chase the “hot dot”, in other words, simply choosing the investment options that have provided the highest rate of return over the past year, 3 years or 5 years. Although those returns could have certainly been generated by superior management, they could also simply be the types of investments that were in the “right place at the right time” given the market environment. Examples could be stock investments during very good periods for the equity markets or longer-term bond investments during a falling interest rate environment. Again it always comes back, in our opinion, to having a game plan in place for what you own and why you own it and maintaining a well- balanced and broadly diversified portfolio given the options available within your company plan.
4. Lack of rebalancing: In good times most employees are very happy to see the value of their 401(k) go up in value so the assumption is “I must be doing something right”. When the market turns, a number of corporate employees look to make large, whole sale, changes within their portfolio to find “better investments”. As one moves through their career, it is important that they rebalance, or recalibrate, their retirement portfolio from time-to-time to make sure they are maintaining the appropriate asset allocation and mix of investments. When stocks are doing well, the equity portion of the portfolio can become over weighted leading to additional, or even unnecessary, volatility and risk exposure. In bear market environments, the portfolio may become over weighted in investments like bonds, cash and stable value funds reducing the long-term growth prospects and overall rate of return.
5. Not knowing the options available: What are all of the options available to you within your company plan? How much flexibility do you have as far as contributing to the plan, the investment options available and being able to diversify and move money while you are still working? Many plans are very “company specific” meaning that the options available within one company plan do not always match-up exactly with the options available within the plan of another company.
6. Ignoring everything all together: Many people look at 401(k) investing within the context of “I contribute a portion of my pay every month, I receive a company match and I am a long way off from actually retiring so I will hope for the best”. Again nothing helps you stay on the appropriate course more than having a game plan, knowing where you are relative to your goals and rebalancing the portfolio back to the appropriate mix of investments that will help you get there. At some point, you are going to need to rely on this money to live so it is up to you to have a course of action in place to hopefully allow you to live the retirement you envision.

What are some common errors that we see post-employment? In other words, once an employee has made the decision to transition into retirement and must now invest their funds in a way to maintain their lifestyle and be able to do the things they want and need to do.

1. Investing for “income” versus “total return”: Many investors feel that when they retire, and are no longer receiving a paycheck, their investment portfolio needs to focus on income investing. Generating enough income, or free cash-flow, to allow them to maintain their lifestyle. In today’s very low interest rate environment it is very difficult, if not almost impossible, to generate sufficient cash flow from simply interest and dividends. In most cases a “total return” approach must be implemented. Investing for “total return” is a technique to generate both growth of principle as well as income, or free cash flow, both of which can be used to cover living expenses over time. By implementing a broadly diversified and properly balanced portfolio, a retiree should aim to generate a combination of principle growth, income and income growth over the long-term.
2. Being “too conservative” with your investment allocation: Determining risk tolerance is a critical step in building an appropriate retirement portfolio but remember that your risk tolerance has to be coordinated with your return need – the minimum required rate of return that needs to be generated by the portfolio to be able to meet your goals and objectives. Most retirees, when it comes to their retirement nest-egg, want to take a very conservative approach to the markets and not expose their retirement savings to the volatility of the stock market. A portfolio made up entirely of FDIC insured bank cd’s, as an example, can often sound enticing. But keep in mind that if you invest your retirement funds too conservatively, you can run the risk of running out of money over time. As an example, if your withdrawal rate is 8% each year and bank cd’s are generating a return of 1%, you will spend the portfolio down in a little over 14 years (all things being equal). The conservative portfolio is not generating a high enough overall return due to the lack of growth (or equity) investments. The retiree is able to feel comfortable knowing their retirement nest-egg is not exposed to the volatility of the market on a month-to-month basis but over the long term, they will suffer principle losses due to an insufficient rate of return relative to their withdrawal rate. It is critical to balance your risk tolerance with your required rate of return by running your numbers and building a portfolio that will help you meet your return requirements as well as feel comfortable with the investments you own and your overall allocation.
3. Failure to rebalance, re-budget and update your plan: Over time things change. Your monthly expenses could increase over time, special circumstance arise and situations change. The portfolio, budgeting plan and withdrawal strategy that worked initially may have to be adjusted as you move through retirement. It is important that you, and your advisor, are continuing to monitor your overall plan and making the needed adjustments. Retirement is a process not a one-time event so it is imperative that you are looking at your situation and re-running your overall retirement financial plan on a regular basis to make sure that you are still on track.
4. Ignoring the impact of the constantly changing tax laws: The tax landscape is constantly changing with regards to retirement, IRA’s, withdrawals, funding and estate planning. These changes can have a dramatic impact on not only what you are doing but also what you should be doing to take advantage of changes that may benefit you. Addressing the changing tax and estate planning landscape and how to navigate it is critical to your long-term success.

Any opinions are those of Christopher Hudson and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Asset allocation and diversification do not guarantee a profit nor protect against a loss. Raymond James and its advisors do not offer tax or legal advice. You should discuss tax or legal matters with the appropriate professional.