What is Derailing Your Retirement?

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Calculating Retirement Chart and MoneyThe 2013 Ameriprise Financial “Retirement Derailers” survey addresses a wide range of risks that have impacted Americans’ retirement savings. The survey was conducted last February by Koski Research and released in May. One thousand Americans (between the ages of 50 and 70, with at least $100,000 in investable assets) were interviewed about events that have “derailed” their retirement plans. Coming in at number three on the list of top 10 derailers is “Losing some retirement savings because of unsuccessful investments”. The description references bad investment choices but covers making emotional decisions that sometimes causes them to sell investments at their low point, and/or keeping their money on the sidelines while the markets recover.

Quantifying how expensive this derailer is has been the focus since 1994 of Dalbar’s Quantitative Analysis of Investor Behavior. Dalbar measures the effects of investor decisions to buy, sell and switch into and out of mutual funds. Their research consistently shows that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest. Dalbar’s recently released 2013 report shows 2012 was no exception. The report showed the average investor earned 4.25% versus the S&P 500 Index of 8.21% for the 20 years ending December 31, 2012*.

Dalbar uses data from the Investment Company Institute which reports mutual fund sales, redemptions and exchanges each month. The study uses this information to calculate the “average investor return” for various periods based on when the fund was being bought or sold. The return is then compared to the S&P 500 index as a way of measuring the impact of investor behavior.

Successful investing requires a long term strategy that acknowledges there will be ups and downs along the way. This strategy will take advantage of the down times by rebalancing into stocks to capture the lower prices. Success also requires that you prepare for the down times by harvesting off some of your gains while the market is doing well to avoid becoming over weighted in stocks. The Dalbar study revealed the average investor does just the opposite. They added aggressively to stocks in up markets and sold in down markets. Buying high and selling low left them with less than half the return they would have gotten from just buying the index and ignoring their investments.

You would think most investors learned their lesson after the market sold off in 2008 and 2009. Many investors sold their stock positions in fear. It was widely reported it would take years for the market to recover if ever. Some of my retired clients told me they doubted the stock market would recover in their lifetimes. Yet in less than 5 years most major averages have reached new highs. The S&P 500 index was up over 13% through mid-year. Yet where are most investors putting their money? They are still investing in bonds.

Investment ChartSource: Investment Company Institute, J.P. Morgan Asset Management. Data includes flows through May 2013 and exclude ETFs.

At least investors have stopped selling their stocks after six years of net liquidations. What makes this so amazing is all bond sectors except high yield have produced negative returns through mid-year. Nothing can derail your retirement like selling your investments after they’ve declined by 40% and then sitting on the sideline while the stock market doubles.

I suspect the reason for this behavior lies in the average investor’s belief that you can only make money in the stock market by being in stocks when they’re going up and out of them when they go down. Not only is this wrong but it is also impossible to do. The importance of having the correct asset allocation and rebalancing regularly are well documented, and investors seem to understand both concepts. Yet few people actually rebalance systematically to take advantage of the market’s fluctuation.

We believe your investment strategy should center on achieving your clients’ financial goals over time. An allocation between stocks and fixed investments should form the foundation of the strategy and should be designed to meet your goals with the least amount of risk. Ideally this allocation will never change. We monitor the allocation and periodically sell some of the stocks when the client has too much in stocks. This happens when the stock market goes up because stocks usually produce a higher return than fixed investments. In a sell off like 2008-2009 the opposite happens. Many of our clients had too much in fixed assets because the stock market dropped. Our strategy called for selling fixed investments to buy stocks. This process forces us to buy low and sell high to maintain the allocation.

Don’t let your emotions derail your retirement. Put your financial goals in writing. Develop a strategy to achieve them. Stick to your strategy.

Rick’s Tips:

  • One reason some Americans say their retirement was derailed was losing some retirement savings because of unsuccessful investments.
  • Dalbar’s 2013 report showed the average investor earned 4.25% versus the S&P 500 Index of 8.21% for the 20 years ending December 31, 2012*.
  • All bond sectors except high yield have produced negative returns through mid-year 2013.

*Source: Quantitative Analysis of Investor Behavior by Dalbar, Inc. (April 2013). Dalbar uses data from the Investment Company Institute (ICI), Standard & Poor’s and Barclays Capital Index Products to compare mutual fund investor returns to an appropriate set of benchmarks. Covering the period January 1, 1993, to December 31, 2012, the study utilizes mutual fund sales, redemptions and exchanges each month as the measure of investor behavior. These behaviors reflect the “average investor.” Based on this behavior, the analysis calculates the “average investor return” for the various periods. These results are then compared to the returns of the respective indices.

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