6. Saving outside retirement funds
An inflated ego has been the downfall of many DIY investors, who habitually confuse bull markets with investment skill. Most eventually succumb to fear and greed.
But still, you let hope triumph over experience: fund managers may be professionals, and the markets reasonably efficient, but you believe you can outsmart them both. So you do your own investing.
Perhaps you will get lucky and do better – after all, you do save on fees. But to justify going this route, you don’t just have to outsmart the market over thirty or forty years, you also have to match the imposed discipline of a retirement fund and the tax breaks it affords investors.
Tax free deductions and investment returns can potentially increase the value of your retirement savings by up to 30%. And you score again because your retirement income is almost always taxed at a lower average rate than the marginal tax you saved on your contributions.
Assuming you do stand above fear and greed, and you do contribute monthly to your savings (despite any budget deficit) and do you resist the temptation to dip into your account every now and again (despite the absence of regulatory shackles), it will still take an enormous amount of skill and luck to overcome the tax disadvantage.
So before you go down this route, you need to ask yourself: do you really feel that lucky, that smart and that disciplined? Well, do you?
7. Insufficient diversification
As we grow older, we come to understand the good sense behind the idioms we learned in high school. One trite saying suggests you don’t put all your eggs in one basket. Investors should heed this advice, because insufficient diversification is bound to give you many “oh cr@p!” market moments, and a fair amount of regret. There are many equity-only bulls who wish they also owned SA bonds and property shares in recent years.
The textbooks will tell you that a diversified portfolio, re-balanced regularly, is likely to deliver a higher return with less risk than a concentrated portfolio. It is the one free lunch to which investors are invited. A diversified portfolio combines a variety of different asset classes, securities and currency exposures to reduce the overall riskiness of your portfolio (provided the investments do not all move in tandem).
If you are overinvested in one asset class or security, you assume concentration risk, the risk that one investment will have a disproportionate impact on your savings outcome. This can work for you or against you. Of course, with hindsight, we regret not having put all our money into, say, the Apple basket ten years ago (then $8, now $675), or even just SA Property one year ago (+35%). But by the same token you could also have bought high-flying Dimension Data at R75 in 2000, and watched it nose-dive to R1.80 over the subsequent three years.
As a retirement investor, you cannot afford the downside risk, as it may ruin your pension. Remember, it’s about reaching your goal with the lowest possible risk; it is not about speculating your way to a dream existence.
8. SwitchingSwitching, as practiced by the average DIY investor, amounts to a buy-high sell-low strategy, which is the well-travelled road to investment failure.
Investment choice has become ubiquitous in South African retirement funds, the ability to choose (and switch) among a selection of funds, investment styles and investment strategies in the belief that one will meet your very own specific needs at a particular time.
But the reality is that when it comes to retirement, you’re not so special – most investors have a similar financial objective. In this context, choice then becomes a curse rather than a cure as it may tempt you to do the wrong thing at the wrong time.
We all suffer from “lane changing” syndrome. Stuck in bumper-to bumper traffic on the highway, we see the other lane is moving faster, but we think it’s temporary. But it keeps moving ahead, so eventually we succumb and move across. It is usually around this time that this lane shudders to a halt, and your original lane accelerates. At first, you think it’s only temporary…and so it carries on.
We bring the same approach to our investments. Despite our good intentions, we are wired to ditch what has done badly, and to embrace what has done well. Fund managers are hired and fired that way, asset managers market their funds that way and brokers recommend investments that way. It takes a disciplined person (or one tied to the proverbial mast) to withstand the lure.
But invariably, what has done well is now fully priced, and what has done badly offers good value.
Studies show that performance persistence is rare; only investors, with strong investment beliefs and a clearly defined investment policy, who rigorously stick to their script, are likely to prevail over the long term. That excludes most fund managers. It probably excludes you too.
9. Market timing
Market timing is the intellectual spin-off of switching. And it’s another self-defeating habit. Yes, we can learn to identify markets that appear cheap or expensive, but we are fools to believe we can accurately predict market turns.
And that is what really counts, because markets tend to run longer and rally sooner than we expect.
Market timers typically get out too soon, and get back in too late. The latter is particularly harmful as a large percentage of gains happen within the first few days or weeks of a rally, when sentiment is still hugely bearish, and a market rally is dismissed as a dead-cat bounce (which sometimes it is, and sometimes it isn’t).
But missing the first move makes it almost impossible to match the average market return, let alone exceed it – long term investors would then have been much better served with a simple “buy and hold” strategy. Studies in the US have compared net fund returns with the average net investor returns; investors typically lag by around 3% (percentage points) pa, because they believe they can time markets.
The above behavior assumes that we apply market timing with a hint of analysis. Unit trust flows suggest that the average DIY market timer does not even do that. Instead they are lagging momentum investors who invest after markets have gone up, and sell after they have come down. This is the classical road to the soup kitchen.
John Bogle, the founder of Vanguard (the largest mutual fund company in the world), named one of the four investment giants of the twentieth century by Fortune Magazine, remarked in an interview with us that “I cannot time markets, I don’t know anyone who can time markets, and I don’t know anyone who knows anyone who can time markets”. Mr Bogle is well into his Eighties, and has met countless investment professionals in his sixty or so market years. Do you really want to bet your retirement trying to prove him wrong?
10. Not staying informed
None of the above is particularly new and insightful; in fact most of it is repeated ad nauseum in the financial media and in retirement fund literature.
The reason many of the above mistakes persist is because so few take an active interest in their pension until retirement looms. We know this anecdotally, and from the number of members who view their quarterly newsletter and benefit statement. (We call this log our “Minority Report”.)
Things change around the time you turn 55. This is the time you will contact HR and enquire about the difference between a defined benefit and a defined contribution scheme. And the time you realise that you will have far less money in retirement than you imagined.
You will ask what when wrong. You will calculate the market return over the last twenty years (the last time you cashed in your retirement savings) and question why you did not get your fair share of that return. You will start lamenting about high fees and the poor advice you received from your broker.
You will curse buying that IT fund in 2000, chasing the commodity super cycle in 2007, and switching into a money market fund in 2009. And you will question whether you really needed that 4X4 twenty years ago, to make your way around the suburbs.
This is the time you will abuse your (comfortably retired) broker, and write angry letters to the local newspaper complaining how the industry exploited your ignorance and made off with your pension.
Yes, this will be your time to rage against the machine. You may as well because it will almost be too late to do anything else now, except increase your savings rate, delay your retirement and lower your expectations.
“If only I’d known sooner”, you think. If only you cared sooner.
