Ben Franklin once said, “An investment in knowledge pays the best interest.” While Franklin was speaking about the benefits of education, this statement also holds true in a literal sense. Sound investment decisions tend to pay off.
However, even with the vast panoply of smart financial planning resources available today, most Americans still fall into common pitfalls when it comes to investing. In fact, our data shows that the majority of Personal Capital Dashboard users make several costly mistakes when putting their dollars to work.
In this post, we discuss three typical investment mistakes – and their easy remedies.
1. Too Much Cash in your Portfolio
Problem: While it’s generally recommended to keep no more than 5% of your long term portfolio in cash or cash equivalents, people often make the mistake of holding too much cash among their assets.
Looking at a sample of Personal Capital Dashboard users, we found they hold three times more cash than they generally need in their investment portfolios, with the average user keeping 14% of their portfolio in cash. Note: Cash or cash equivalents are low yield investments in money markets, short term bank CD’s or U.S. Treasury bonds.
Even more striking is the fact that for nearly 10% of users, cash in brokerage accounts represents over 50% of their entire investment portfolios, and this is not even including savings and checking accounts, where they could actually be earning higher yields.
Fix: Get in the stock market! When you put a larger percentage of your investment into stocks, corporate bonds or equities, you’re putting your cash to work harder and will get a larger return.
2. Too Many Mutual Funds
Problem: Nearly 60% of the sample of Personal Capital Dashboard users have over half of their investment portfolios in mutual funds. While mutual funds were once believed to be cutting edge, the investment world has changed. Mutual funds today tend to be costly; for the average mutual fund, the expense ratio is 1.16%. With the power of compounding interest, this could be very costly in a retirement portfolio.
Additionally, mutual funds are tax inefficient when compared with exchange-traded funds. Actively managed mutual funds are traded often during the year, and the more they are traded, the higher your tax burden. And, that’s not all: if you purchased a mutual fund in October, you are still responsible for paying taxes on a full year of gains at tax time.
And finally, the vast majority of mutual funds under perform their benchmarks. According to the S&P 500 Indices Verses Active Funds (SPIVA) indexes, mutual funds consistently lag year after year. In fact there isn’t a ten-year period on record when mutual funds have done better than their counterparts.
Fix: Get out of poor performing mutual funds, and put your money into passive indices. There’s a range of investments that aren’t going to drain you as much in service fees or taxes, and will get you more financial mileage dollar for dollar.
3. There’s a Mismatch between your Portfolio and your Risk Tolerance.
Problem: A person’s investments should match both how they’ve defined themselves as an investor (risk tolerance) and their ability to take risk (risk capacity). If you’ve got a high risk tolerance and capacity – say, you’re young and deciding on the risk profile of retirement funds you’re not likely to need in the next 30 years – you could have 85%+ of your portfolio in equities, for example.
Unfortunately, we’ve seen a mismatch between stated risk tolerance and actual investment portfolios. Nearly 25% of the sample of Personal Capital users with a stated risk tolerance of “aggressive” or “highest growth” have less than 50% of their portfolios in stocks. That means that they’ve stated that they’d like to be making “higher risk” investments, but for some reason are not doing so. Conversely, nearly 25% of users with a stated risk tolerance of “Conservative” or “Highest Safety” have over 75% of their investments in equities.
Fix: If your risk tolerance doesn’t match your portfolio, chances are you haven’t gotten the advice you need to make choices that are aligned with your investment strategies. If this is the case, find a financial planner to help you with your allocation of resources, so that you can match your wants, hopes and desires up with reality.