{"id":82,"date":"2008-03-06T02:39:21","date_gmt":"2008-03-06T10:39:21","guid":{"rendered":"http:\/\/marketriders\/weblog\/?p=82"},"modified":"2017-03-09T17:18:52","modified_gmt":"2017-03-10T01:18:52","slug":"barrons-online-3-ways-investors-ruin-their-nesteggs","status":"publish","type":"post","link":"https:\/\/www.marketriders.com\/investing\/barrons-online-3-ways-investors-ruin-their-nesteggs\/","title":{"rendered":"Barron's Online – 3 Ways Investors Ruin Their Nesteggs"},"content":{"rendered":"

by Karen Hube<\/cite>
\nMonday, March 17, 2008<\/cite><\/em><\/p>\n

These are scary times for investors trying to shore up their retirement
\nportfolios. Stocks’ values are down, inflation is ticking up and home prices
\nare sliding. But as investors nervously eye all that, they may be overlooking
\nthe biggest threat of all: themselves.<\/p>\n

“How you react to negative news about the markets can do far more
\ndamage to your retirement portfolio than temporary trends in the market,”
\nsays Mark Cortazzo, an investment adviser at Macro Consulting Group in
\nParsippany, N.J. “Investors can truly be their own worst enemies.”<\/p>\n

While investors are prone to making mistakes no matter which direction the
\nmarket is headed, when stocks lose value — as they have for four consecutive
\nmonths — investor errors can have more exaggerated effects on wealth, Cortazzo
\nsays.<\/p>\n

So how much damage does the average investor inflict upon himself in real
\nnumbers?<\/p>\n

At the request of Barron’s<\/em>, Christopher Cordaro, an investment
\nadviser in Chatham, N.J., with Regent Atlantic Capital, ran some
\ncalculations to answer this question, and the answer isn’t pretty.<\/p>\n

Bottom line: Simply by making three of the most common errors — failing to
\ndiversify wisely, trying to time the market and overpaying on investment
\nexpenses — you would have missed out on $375,000 of gains on a $1 million
\nportfolio invested for the 10 years through January 2008.<\/p>\n

Cordaro found that a wisely constructed portfolio free of investor error
\nwould have returned an average annual 6.86% during that period and grown to
\nabout $1,942,000. But factor in the three errors, and the return shrinks to
\n4.59%, while the ending account balance drops to about $1,567,000. In general,
\nthe smart portfolio was broadly diversified in terms of both asset class<\/span><\/span> and country. It made no attempts to call tops and bottoms in the market, and it
\nsteered clear of pointless but all-too-common fees.<\/p>\n

The worst part, Cordaro says, is that investors often don’t even realize
\nthey’re sabotaging their nest eggs — because the slippage in return isn’t
\nsudden or drastic. “It’s small enough that they don’t notice it, but it is
\nslowly eating away at their financial independence like a cancer,” he
\nsays.<\/p>\n

The good news? If you know what to look for, chances are you’ll be able to
\navert disaster. Here is a rundown on the three most common and costliest
\nmistakes that investors make with their nest eggs.<\/p>\n

Neglecting <\/strong>Asset Allocation<\/strong><\/span><\/p>\n

Practically all investors would agree that they want the best returns and
\nthe lowest possible risk. But when it comes to setting up a portfolio to
\ndeliver on that promise, many investors don’t go the distance — and they pay
\ndearly for it.<\/p>\n

The best way for an average investor to achieve the highest risk-adjusted
\nrewards is to allocate investments broadly across different asset classes. Yet
\nfew investors do so: According to a 2007 survey of 401(k)<\/span><\/span> assets by the Profit
\nSharing<\/span><\/span> and 401(k) Council of America, the average investor holds
\nsome 25% of 401(k) assets in his own company stock. Beyond that, at least a
\nthird of assets are in domestic stocks. Less than 8% of retirement-plan assets
\nare in non-U.S. stocks, and fewer than 1% are in real estate.<\/p>\n

In Cordaro’s example, you can see how an investor can buff up a return by
\nrefining his asset allocation. A simple allocation of 60% in large U.S. growth and
\nvalue stocks and 40% in intermediate bonds would have delivered a 5.2% average
\nannual return in the 10-year period ending January 2008. Add a sprinkling of
\nsmall U.S.
\ngrowth and value stocks, and large foreign stocks, and you boost your return to
\n5.7%. Better yet, add some world bonds, emerging markets and real estate, and
\nthe return plumps up to 6.4%.<\/p>\n

That latter portfolio, Cordaro says, was invested 30% in large U.S. growth
\nand value stocks, 10% in small U.S. growth and value stocks, 10% in large
\nforeign growth and value stocks, 5% in emerging markets, 35% in intermediate
\nbonds, 5% in world bonds and 5% in real estate.<\/p>\n

Juggling a number of asset classes isn’t always easy. Jay Berger, a partner
\nat Independent Wealth Management in Traverse City<\/span>, Mich<\/span>.<\/span>, said that in 2006,
\nclients panicked over the Pimco Commodity Real Return Fund’s 3% decline.
\n“We explained that we need a portfolio with assets moving in different
\ndirections. The best analogy is: Look at it as a perennial garden. <\/a> If
\neverything is in bloom at the same time, that probably means everything will
\nwilt at the same time.”<\/p>\n

Timing the Market<\/strong><\/p>\n

Investors have such a dismal record of being able to time the market that
\nmutual-fund inflows and outflows appear to be contrary indicators of which way
\nthe market is heading, says Meir Statman, a finance professor at Santa Clara<\/span> University<\/span><\/span> in California<\/span><\/span>.<\/p>\n

“It’s not the perfect-idiot forecast,” he says, but it’s close.
\nIdeally, of course, you would want to sell your holdings when prices are high
\nand poised to drop, and buy stocks on sale, right before a run-up in values.<\/p>\n

But over the past decade, investors have done the exact opposite. The month
\nwith the biggest-ever net inflows of assets into stock mutual funds occurred in
\nFebruary of 2000, “which was the doorstep of one of the worst declines in
\nhistory,” says Ernie Ankrim, chief investment strategist<\/span><\/span> at Russell Investments. The biggest outflows were also poorly timed: Some of
\nthe biggest occurred in the months leading up to October 2002, when the market
\nhit bottom.<\/p>\n

“This kind of behavior of getting excited after good news and scared
\nafter bad news causes investors to give up between 2.5 and three percentage
\npoints a year,” Ankrim says. “The whole reason investors put up with
\nthe volatility of stocks is to gain about three or four percentage points over
\nbonds — if we give most of that back, that means we’re accepting all of the
\nvolatility of the stock market for no good reason.”<\/p>\n

In the 10-year period of Cordaro’s example, investors suffered more modestly
\nthan Ankrim’s estimates, but losses were still significant. Using actual
\nmutual-fund flows over 10 years ending January 2008, Cordaro found that market
\ntiming<\/span><\/span> cost the average investor a half percentage point of
\nreturn each year. On his $1 million portfolio, that means missing out on
\n$93,000 in gains.<\/p>\n

You don’t need to be near a long-term market top or bottom to do serious
\ndamage. From 1980 through 2006, investors who missed out on just the five
\nbest-performing days in the Standard & Poor’s 500
\nindex<\/span><\/span> would have ended up with 26% less than someone fully
\ninvested in the index during that period, says Carolyn Clancy, executive vice
\npresident of Personal Investments, a division of Fidelity Investments<\/span><\/span>.
\n“Missing just 30 of the best-performing days would have reduced the value
\nby 73%,” she adds.<\/p>\n

Another kind of market timing is more passive, yet still destructive: It is
\nsimply to stop feeding more money into your investments in rockier times.<\/p>\n

Consider this: According to a 2007 study by Dalbar’s, a mutual-fund research
\nfirm, if you had invested $10,000 in the S&P 500 index over 20 years
\nthrough December 2006 in a sporadic pattern that matches actual behavior of mutual-fund
\ninvestors<\/span><\/span> during that period, you would have ended up with a
\ntotal of $33,252.<\/p>\n

If, however, you had systematically invested the $10,000 in equal increments
\nover 20 years — through good times and bad-you would have ended up with
\n$42,877. The study found that even if you chose a fund that captured only 75%
\nof the S&P 500<\/span><\/span>‘s return, by dollar-cost averaging<\/span><\/span> you would still end up with more than if you had sporadically invested in the
\nS&P 500 fund.<\/p>\n

Paying Too Much<\/strong><\/p>\n

Before you win cocktail-bragging rights for earning a robust return on an
\ninvestment, be sure to factor in how much you paid for your winnings through
\nexpenses and fees.<\/p>\n

While more investors than ever before are seeking out low-cost mutual funds,
\nthere are still investors who believe that they need to pay higher expenses for
\nbetter performance, says Mercer Bullard, a securities-law professor at the University<\/span> of Mississippi<\/span><\/span>.
\nBut, he adds, there is no evidence to support that. Higher fees simply do not
\nindicate better management.<\/p>\n

Consider S&P 500 index funds<\/span><\/span>. While the performance
\nof these funds is practically identical, given that they mirror the same index,
\nexpenses are all over the map — some funds charge no load, some have no load
\nbut do have a so-called 12b-1 fee<\/span><\/span>, which is an operating expense, and
\nyet others have both a load and a 12b-1 fee.<\/p>\n

A 2006 study by Zero Alpha Group, a network of advisory firms, and Fund
\nDemocracy, a shareholder-advocacy group, looked at how much investors would pay
\nin fees if they invested $10,000 in these funds for 20 years and earned an
\naverage annual 10% gain. It found that the average investor would have paid $2,582
\nin fees in the lowest-cost fund; $3,744 in the fund with only a 12b-1 fee, and
\n$7,600 in the load fund<\/span><\/span> with the 12b-1 fee.<\/p>\n

In Cordaro’s hypothetical $1 million portfolio invested 10 years ago, he
\nlooked at the impact that half a percentage point in fees can make on a
\nportfolio. While his best-case portfolio earned an average annual return of
\n6.86%, he found that if higher fees knocked half a percentage point off of
\nreturns, an investor would have ended up with $1,848,865 rather than
\n$1,941,837.<\/p>\n

Taken altogether, Cordaro says, the impact of investor error — even
\nseemingly small ones — can be grievous over the long term. “We’re talking
\nabout the difference in being able to retire in comfort or having to work many
\nmore years to meet your goals.”<\/p>\n

\n","protected":false},"excerpt":{"rendered":"

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