|Boost Retirement Incomes by 23 Percent
How you can help your clients.
October 22, 2009
Your clients might be walking away from a huge chunk of their retirement income for no good reason. Over the course of a 35-year career, the typical 401(k) member losses 23 percent of their retirement funds because they makes bad investment choices.
According to a new National Bureau of Economic Research study, your clients can boost their retirement income by 23 percent by simply avoiding a few minor mistakes. And even if they are already retired, they have a lot to gain by paying attention to this study.
Wharton School at the University of Pennsylvania and Vanguard Group, the mutual fund giant, put together a group of researchers. They looked at over one million 401(k) participants at more than 100 companies. They examined these people's investment habits and results and came to some surprising conclusions.
The researchers concluded that 401(k) savers underperformed by 0.11 percent per month when compared to a global index. That's not much on a monthly basis but it's enough to lob off 23 percent from a retirement portfolio after 35 years.
And you know what?
If your client's account value is 23 percent lower than it could be, their income is going to be reduced by 23 percent as well — once they start tapping into it.
Why Did the 401(k) Savers Underperform?
There were two reasons:
People often load up on their own company's shares because they feel obligated. Other times, they buy shares at a discount to their market price. That's not a bad deal. In fact, it can be a great deal.
But either way, when you have too much money in one stock for too long, you take on way too much risk. Of course, this can work out but it can also mean disaster. (Does the name ENRON mean anything to you?)
The researchers found that investors kept too much money in a very narrow band of investment choices rather than spreading it around and it hurt their performance.
OK. I'm not going to argue with the data. I'm not a huge proponent of asset allocation, which is another way to say diversification.
So does this study prove I'm wrong?
We don't know how the people in this study managed their money. We don't know if they were "buy and hold" investors or if they managed their portfolios actively.
But I think it is fair to conclude that if your client is a passive investor, they are probably going to do much better if they diversify than if they "buy and hold" a narrow range of funds.
This study proves that very small improvements over a very long period of time really add up. It makes sense for all of us to pay attention to little mistakes because they add up to be big ones over time.
What Use Is This to Your Clients If They Are Retired?
Even though this study looked at people who were still actively employed, it's actually MORE important to your clients if they are already retired. I say this for a few reasons:
For me, the take-away is that it's critically important to look at how your clients make their investment decisions. Having a retirement income that's increased by 23 percent can make all the difference in the world to your clients.
I know it can be intimidating to learn about investing if your clients don't know much about the subject. Because it's complicated and intimidating (to some of us) we sometimes throw up our hands. And since nobody can guarantee that one approach is better than the other, it can be easy to just make a few decisions and then ignore their options over time. It's certainly the easiest choice to make.
But as the study indicates, it's probably the most expensive way to go.
There are plenty of free resources to help your clients improve their understanding of investing. Take advantage of them.
Are your clients happy with the way they manage their retirement funds? Do they feel intimidated by the available choices? How do they make their investment decisions?
Rate this article 5 (excellent) to 1 (poor). Send your responses here.
Neal Frankle, CFP, is the author of Why Smart People Lose a Fortune: 5 Steps to Restoring Your Wealth and Sanity.
The material in this article is general information and not meant to provide specific investment, tax or legal advice. Investing in the stock market involves risk.