When it comes to investing for retirement, many of us aren't saving enough. That problem is further compounded by the fact that you might not be earning the return you could be.
In fact, according to Mitch Tuchman, the Managing Director of Rebalance IRA, many investors are losing out on investment returns to the tune of 3 percent a year.
Where does he get this number? “It happens to be the difference between what well-run pension funds get — 8 percent — and what everyday investors make doing it themselves in their 401(k)s and IRAs,” says Tuchman.
This means that you are probably seeing annualized returns of about 5 percent, when you could be getting 8 percent returns. It doesn't seem like a big deal, but over time the effects of compound interest can turn it into a major setback.
Tuchman uses the hypothetical Joe and Mary to illustrate his point. He says that if they both start with $100,000 in their accounts, and max out their yearly contributions, while lowering their risk as they approach retirement, that 3 percent matters a great deal. Here are the numbers if Mary has a return that is 3 percent higher than Joe's:
- 35 years old, she retires at 65 with $740,000 more than Joe.
- 45 years old, she retires at 65 with $252,065 more than Joe.
As you can see, that money matters. And, of course, the longer you are investing for retirement, the bigger the difference is. In fact, this illustration is great for showing the power of compound interest over time. It's amazing the difference 10 years can make.
What Mistakes Do Many Investors Make?
So, why are many investors earning 3 percent less each year than they could be in their retirement accounts? Tuchman offers three reasons that investors are underperforming:
- Emotional investing: First of all, getting to emotionally involved can wreak havoc with your portfolio. “They manage by emotions and buy and sell at the exact wrong times,” Tuchman says. When you sell low because of panic, or buy something because you are excited about it (and not the fundamentals), you can set yourself up to underperform.
- Lack of knowledge about the financial industry: Another big problem, according to Tuchman, is that many consumers don't get how the financial services industry often works. “[They] do not understand how the financial services industry makes money, thus paying exorbitant fees for biased advice,” he says. Conflict of interest can be a huge issue, and it can erode your long-term returns as you pay more in fees for results that aren't right for you.
- Small picture thinking: Too often, investors neglect the bigger picture and focus on the here and now. “[Investors] do not look at their investments holistically, leading them to take more risk without getting commensurate returns,” says Tuchman. Instead, you need to understand how your investments fit into the big picture. Know your goals, and be realistic about risk and return.
If you can overcome these mistakes, or get help from a reputable financial professional without a conflict of interest, you can improve your portfolio's overall performance over time — and improve your chances for a successful retirement.