The first seven “don’t do’s” were so popular it’s time to take it to the next level. First, some background.
Part of what we do at MOAA is conduct financial classes on military bases and counsel individuals to be savvy financial services consumers. Many of the topics I write about stem from discussions I have with class participants. I find too many participants have ideas of money and investment management based on misconceptions or media induced bad habits.
The media are not on my good side because their stories tend to reinforce bad habits rather than good habits. For example, their stories tend to stir emotions (greed, fear, curiosity) which suggest the need to take some form of action. Generally, taking action (trading investments, swapping funds in your 401k, TSP, IRAs) works against average investors. Even the everyday reporting of the DOW and SP500 indexes seems benign but actually encourages a trader mentality.
These “Don’t Do” articles attempt to counterbalance the media by breaking down some misconceptions. Of course, I can only scratch the surface so to more fully understand these issues you may want to read other posts in this blog.
Don’t think or do these…
1) Think you are a master stock or fund picker. If you change the stocks/funds in your 401k, TSP, IRAs or investment accounts thinking you can pick the winners, you are fooling yourself more often than not. Sure we are intelligent people; we’re just not professional investment analysts. Even professional investment analysts miss the target all the time and they live in the investment world 24-7 and have access to resources and business leaders you wouldn’t believe. How can you do better with information from public sources? Too often people’s investment strategy is based on feelings, the media or Uncle Joe. These are terrible sources for making investment decisions. When you trade/swap funds trying to time the markets, the success of your investments depends on current events, politics, markets, economies, the companies, consumers, media coverage, market timing and some luck. Over the long haul, you are better off investing and sticking with the market indices; SP500, Dow, etc. Don’t feel bad that you can’t beat the markets; the pros can’t do it either.
You don’t have the time to become an expert at picking investments if you have a career and a family. You need proven investment strategies that do the work for you as much as possible. You need a plan that removes the emotion associated with the ups and downs of the markets. Something that removes the guess work. Something based on history and data; not trends, current media and hot tips from family and friends.
MOAA pamphlet 1-912, The MOAA Investors’ Manual, provides the details you need to know to properly invest and maintain a personal life. MOAA members can order by calling MOAA or download at http://www.moaa.org/InvestorsManual.
2) Rotate cars and have a continuous car loan/lease payment. This isn’t just about cars actually. Wealth is built by living beneath your means and buying assets more than you spend on liabilities (Assets = savings/investments you own and grow over time. Liabilities = money you spend and will never see again.) For the purposes of this article I define wealth as having plenty of assets for a lifelong comfortable retirement according to your definition of comfort.
If you are living paycheck to paycheck, you lose. The foundational building blocks of your financial situation are knowledge and management of “income” and “outflows”. Outflows are either in the form of “assets” or “liabilities.” Your biggest liability is usually your car. To decrease the auto liability, buy a car and drive it until the wheels fall off. Maintain it to last. Measure the outflows to decrease the liabilities and to maximize the assets.
3) Overweight one or two market sectors in your portfolio. A market sector is a collection of businesses that produce and sell similar goods or services and are in competition with each other. This means don’t own a large percentage (of your total investment portfolio) of the financial market (like banks), or commodities (gold), or high-tech businesses in your portfolio. In other words, don’t put all your eggs in one basket.
The dot.com/internet stock bubble blow-up is a prime example of why this is important concept. Look what happened to people when practically everyone’s portfolio was overloaded in high-tech investments. The media touted high-tech in the 1990s and said “…this time it’s different…” High-tech was here to stay and its constant high-paced evolution would keep it evergreen in the markets. Bull. It’s never different. The circumstances and means change but the bubble is still caused by overly exuberant humans—same song 42nd verse. The 43rd verse is when the housing and banking industries blew-up in October 2007.
Next time someone says “this time it’s different”, run in the opposite direction. But even better would be that you keep your holdings well diversified among various industries and asset classes. Don’t let a bubble take you down.
How to spot a bubble:
- Listen to the media. One sector of the economy will be getting massive coverage. There will be experts wondering how much higher it will get and whether it’s the right time for investors to invest.
- Look at a chart of the industry. Has there has been a steady rise over years?
- Salespeople and marketers start touting the investment for you to purchase. Salesmen take advantage of the media talk. Salesmen will play on your greed or fear.
- The great unwashed masses start to talk about it. When people who know nothing about investments start talking up an “opportunity”, trouble isn’t far. When the cabbie or your know-nothing uncle talks to you about an investment, sell or decrease your allocation.
4) Take a pass on contributing to your 401k/TSP. “My 401k doesn’t match my contributions so why should I invest in it?” “The TSP doesn’t match contributions so forget about it.” “I’ve got my own retirement investments. I don’t need a 401k/TSP.” Doh! Whether you get a match or not, contribute to your 401k or TSP before you contribute to any other retirement account (like IRAs). Make it a goal to max-out your 401k or TSP at some point—the sooner the better. Only after you max-out your 401k/TSP contributions, then you can contribute to other retirement accounts. Why?
How much can you invest for your future in an IRA? $5500. Less to none in a Roth IRA if you make too much money. How much can you invest in a 401k/TSP? $17,500. $17,500 a year even in a Roth 401k/TSP no matter how much you earn. Now how much value for retirement can you accumulate in a 401k/TSP versus an IRA?
What are the tax benefits of your retirement accounts? Your annual tax deduction in a traditional IRA depends on your annual income but the best you can get is $5500 (yes, $6500 for you folks age 50 and over).
For a traditional 401k/TSP, you can reduce your taxable income up to $17,500 regardless of your income level (yes, $23,000 for you folks age 50 and older). For a Roth IRA, assuming you can contribute, your tax benefits are in the future in retirement when the withdrawals are tax free.
For a Roth 401k/TSP same deal. However, how much tax-free withdrawal value will you have in a Roth IRA (assuming you can contribute due to your income) versus a Roth 401k/TSP where you are allowed to contribute $17,500 a year regardless of your income level?
Finally, how much does your IRA cost you in various fees and expenses versus your 401k/TSP. A TSP is the cheapest investment account you will ever own…period. “So what” you say. Every penny you pay in extra fees or expenses eats away at your investment return. It looks like no big deal in the short term. But it’s huge money over decades—money you won’t have for retirement purposes when you’ll want it.
5) I don’t need to budget. I’m not going to say you need to control your income and expenses down to the penny but you have to maintain some visibility on your income and outflows every month. If you don’t have some visibility, you can’t judge your results or financial status. You will overspend and under save. At the very least, pay yourself first and live off the rest. Paying yourself first means the first 5, 10, 15% of your paycheck goes into savings, investments or retirement accounts that you won’t touch. You live off the remainder of your pay. Don’t use credit or loans. Adjust your living expenses to live beneath your means. You should have enough in a savings account to use in the case of emergency so you don’t have to turn to a credit card or loan. If you are living on credit, you are living above your means. That has to stop for your financial future and peace of mind.
Image by Flickr user ota_photos.