Charlie Munger once said, “the first rule of compounding is to never interrupt it unnecessarily.” Compounding your money year after year is a key to growing wealth. To benefit from compounding without interruption, you’ll want to reduce the big investing mistakes.
In part 2 of this two-part series on big investing mistakes, we’ll break down 9 more big investing mistakes to avoid on your path to financial success! If you missed part 1, read it here. Here we go with part 2…
Just like diversifying individual investments, you want to diversify exposure to tax rates. Retirement accounts offered in the workplace are, by default, pre-tax accounts. Most people end up with the majority of their investments in these traditional retirement accounts. If this is the case, your tax rate will be determined by future rates when you withdraw the money. We have no idea what that might be!
Because of the unknown future tax rate (and laws), it’s important to diversify investment account types, such as traditional pre-tax (401k, 403b, IRA), after-tax, or tax-free (Roth) and taxable accounts. This gives you the ability to navigate taxes without locking you into todays or future tax law. Tax diversification is one of the most important strategies to reduce your lifetime tax bill.
You can’t avoid taxes, but you can limit them. When investing in a taxable brokerage account, start by utilizing tax-efficient investments. Many people invest “per account” without looking at the big picture. This causes each account to have a similar investment mix of stocks and bonds regardless of retirement or taxable account.
Enter asset location. This strategy can reduce the tax drag in a taxable account by investing in growth stocks or tax-efficient funds. Tax-efficient investments are those that do not pay large capital gains, income or have large dividends. Tax efficiency is the main reason why ETFs (exchange-traded funds) are preferred over mutual funds.
The stock market is hard to beat. Why is that? The stock market doesn’t have emotions. Humans are emotional creatures. Especially when it comes to money. When a portfolio is not correctly aligned to your risk tolerance, you’ll notice it at the wrong time. Such as when your portfolio drops in value below what you can stomach. Then emotions kick in, and you might make big adjustments. It’s ok to make proactive adjustments, but reactive moves with investments can hurt long-term returns.
It would help if you built your investment portfolio because investments will drop in value many times during your lifetime. So have realistic expectations and build a portfolio that can weather the storm.
The stock market is always a step ahead. By the time you get the news, so has everyone else. This means the market has already digested the information and begun pricing in future expectations. Thus, the odds are stacked against market timers.
Think about it this way — if you do buy at the right time, you then have to sell at the right time. This forces you to make two good decisions. That’s hard to repeat over the long term. Remember, time in the market beats timing the market. Time is your friend.
Cash-value life insurance is often sold as one size fits all investment. Instead, insurance should be purchased for insurance needs, not as a way to accumulate wealth.
Insurance products are expensive, confusing, and don’t live up to their promises. They’ll likely put a drag on your overall wealth accumulation.
For the majority of folks, term insurance fits every need. It properly covers your life and allows for extra cash flow to invest. There are a few reasons high net worth families might need cash value life insurance, but that’s beyond this post.
Get life insurance in place for those who depend on you. But don’t get sold the expensive promises of life insurance as an investment.
If you don’t have GPS, you won’t know where you’re at or where you’re going. So while a spontaneous road trip to nowhere is exciting, it doesn’t quite work that way for your long-term investments.
Investments need a reason and a GPS to get there. An investment plan serves as a guide that can help you choose investments, determine risk tolerance, rebalance, and achieve your goals. Without an investment plan, you’re hoping. Hope is not a plan.
This might be the easiest mistake to avoid and fix. Many investors pay too much on unnecessary fees. Unnecessary fees are those that provide little value. Look at the expense ratio of your funds in your investment accounts, such as your 401k, 403b, IRA, Roth IRA, or brokerage account. If you’re paying more than 0.25% to hold a passive index fund, you’re paying too much in fees.
For example, a passive index fund, such as SPY tracks the S&P 500. This fund costs investors 0.09% to hold. On the flip side, RYSYX, the Rydex S&P 500 fund, costs investors 2.4% to hold! Both are S&P 500 index funds and have a 2%+ difference in fees!*
*These funds are used for illustration only and are not recommendations.
There are many factors out of your control when it comes to investing. This is why investors are rewarded for taking risks — the unknowns and uncontrollable. But, unfortunately, many investors spend too much time worrying about things outside of their control and lose sight of the things they can control.
You have no control over the stock market’s daily fluctuations, the economy, interest rates, and investment returns.
You can control setting long-term goals, your savings rate, your emotions, and your asset allocation.
Maintaining focus on the things you can control will increase the probability of your long-term investment success. Conversely, worrying about things you can’t control will only serve as a distraction and potentially drag down your investments.
In life and finance, people accumulate a lot of stuff. When it comes to investing, you might accumulate many different accounts over the years. This can be things like multiple old 401k’s, IRAs, and other investment accounts. Too many accounts mean more work, more confusion, and less simplicity.
By consolidating and simplifying investments into fewer accounts, you can better manage and understand your money.
Reducing investing mistakes can positively impact your long-term returns. If you don’t want to worry about potential investing mistakes or want to learn how we can help improve your investment portfolio, let’s chat!