When a young child misbehaves, the parent takes action to correct the inappropriate behavior and encourages the better behavior. Working with adults when dealing with their 401(k) or other investments is a bit the same. The only problem is that inappropriate investment behavior not only impacts the retirement income of the participant but can also impact the beneficiaries.
Here are the four most common ways to “misbehave” relative to your 401(k).
- Chase the returns of funds after the returns have already happened. What often occurs is the participant looks at last year’s performance report and than elects to move the account balance to maybe one to three of the highest performers. Past performance is not a good predictor of future performance and this strategy is the most common form of misbehaving.
- Jump to cash or bonds after the market has slumped (selling low). There were lots of folks who did not understand how much risk was in their 401(k) and that when the market tanked a couple of years ago, their balances dropped more than they expected and then over reacted and moved to the side lines. The problem with this is that one never knows when to get back into the markets and they missed out on the majority of the recovery that occurred.
- Purchase the funds that are doing the best at the time (buying high). It is everyone’s desire to buy low and sell high but people want to buy what is hot right now even though it may not make sense…and what was expensive often ends up on sale at some later time. It is better to have an appropriate allocation and to rebalance as needed, selling some of the “hot “ assets classes and buying some of those that are on ‘sale” (out of favor.)
- Follow the advice of the investment entertainers such as on CNBC, or Jim Kramer. It is never a good idea to mix entertainment and your future income. Remember that the purpose of the shows is to be entertaining and attract bigger audiences so that the advertising revenue will earn the studio larger returns. This information is never custom tailored to your situation.
It has been established that the single most important factor that determines portfolio return is the current asset allocation over time. Chasing returns, market timing or following the crowd are not good ways to safeguard or maximize your 401(k), so please do not make those mistakes.