You don’t have to be a financial whiz to avoid making big mistakes with your investments.
Before we get to the mistakes themselves, let’s talk dreams. Picture yourself at retirement age. Where are you – in a house by the beach? In a penthouse in
Write down the answers to these questions. They’re your goals.
Now, working backwards – and putting aside, for the moment, any thoughts about particular investments – how much money will you need in the bank, say, 10 years before retirement, in order to reach your goal? How much 20 years before retirement? If you think you’ll need $1 million at age 65 and you can earn 4 percent on your portfolio, any time-value table will show that you need at least $680,000 at least 10 years before retirement and $460,000 20 years before retirement. These figures assume no additions to your savings along the way, but they’re good enough for our purposes.
Put all this in writing, too.
Now look at the money you have today. How much, assuming no additional savings, will your savings grow until you reach retirement? Will you have your $1 million?
If the answer to that second question is, “Nope,” the next step is to figure out how much you need to save now in order to reach your goal, putting aside, once again, any particular investment strategies.
Money Mistake #1 - Failing to Plan
Do you know what you’ve done so far? You’ve avoided the biggest mistake people make in investing their money: They don’t plan. To be sure, you don’t have a plan yet. But you’re off to a good start, because you know where you want to go and what the signposts of success will be – so many dollars 10 years before you retire, so many dollars 20 years before then, and so on.
Putting together a plan means deciding where to invest your money, which brings us to the second and third biggest mistakes people make in investing their money – betting on the market and failing to diversify.
A good plan doesn’t just allocate money among stocks, bonds, and other assets such as real estate. It allocates money among different classes of assets within each of those categories – for example, money in growth stocks, in dividend-paying stocks, in Treasury bills, and so on. Putting together a plan is a crucial process, and there is no end to the advice you can find, some of it contradictory. But you don’t need lots of advice to put together a perfectly good plan on your own, because you’re almost ready to start.
Money Mistake #2 - Betting on the Market
Too many investors – the thundering herd – buy the latest hot stock, try to time the market, or load up on assets close to their hearts. Buying hot stocks is a fool’s game; by the time you learn about the latest hot stock, everybody who’s going to make money on it has already done so, including the seller of the stock you buy. Don’t do it.
Ditto trying to time the market. Even the pros who work the floors of the stock exchanges don’t do this well, and they have access to real-time information. And you know what? Every position they take based on market timing is a bet. Don’t bet. Investors win. Bettors lose.
Money Mistake #3 - Failing to Diversify
Last but not least, if you want to avoid the third big mistake on our list – failing to diversify – don’t buy the stock of your favorite carmaker, for example, no matter how much you like your sled, and don’t load up on aerospace paper just because you have a pilot’s license.
Now, diversifying doesn’t mean buying different stocks willy-nilly. It means limiting risk throughout your portfolio by buying assets – stocks, bonds, corporate paper, whatever – whose prices don’t move in the same direction at the same time.
Stock jobbers call this buying “non-correlated” assets, and you can understand what they mean by thinking of the poor soul who buys the stock of a favorite carmaker. Does this person diversify risk by buying the stock of a second carmaker? By buying the stock of a tire maker or supplier of car seats?
Nope. Such investments concentrate risk, since the fortunes of carmakers and their suppliers tend to follow one another. For this investor, the better idea is to buy the stock of companies whose fortunes don’t depend on the auto industry – maybe utilities, insurers, or residential real estate developers.
The Investing Answer: It can take some technical know-how to balance one risk off of another, and at some point you might want to seek professional help. For that matter, depending on your circumstances, you might want help in developing the whole plan, not to mention monitoring performance as time goes by.
However you do it, if you start out intent on having a plan and determined to avoid the thundering herd and, last but not least, diversify your portfolio, you can head toward retirement confident that you’ll enjoy a comfortable one.