Investing missteps can cost you.
Say you leave a job and cash out your 401(k). If you are younger than 59½, the IRS will want you to pay income taxes on it right away, and they’ll smack you with a 10% penalty.
And it’s not just a matter of getting a smaller amount. You are also forfeiting decades of growth on that money, which you’ll need in retirement. This early withdrawal calculator shows what you’re really giving up.
There’s a lot to learn about investing. It may feel scary and impossible to learn. Don’t let it stop you from starting, though, because it can be a great way to build wealth even when the stock market is rocky.
These five gaffes are easy to make and even easier to avoid.
You don’t get compounding
Start investing when you’re young. You have decades ahead of you, says Mike Loewengart, vice president of investment strategy at E-Trade in Jersey City, New Jersey.
Once upon a time, savings accounts gave you compounded interest, but the yield is no longer as good since interest rates are so low.
“Compounding is a simple way of saying that interest is building on interest,” Loewengart said. “That long runway is such a powerful advantage.”
You misuse funds
Risk tolerance, diversification, asset allocation, rebalancing, equities, sectors. If you’re one of those who throws up their hands and says, “Just do it for me!” there’s an investment just for you.
It’s called a target-date fund, and it’s preset, like a cake mix. A target-date fund has the right composition of stocks and bonds to match your age and investing horizon.
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But there are two ways to mess up your target-date fund strategy. First, you might try to make it diversified by adding more funds. “Especially for younger people, the funds five or 10 years apart are very similar,” said Jeanne Fisher, a certified financial planner with Global Retirement Partners in Nashville, Tennessee, and ambassador to the CFP Board.
Another way of defeating the fund’s purpose: investing in an S&P 500 index fund, for instance, that duplicates what the target-date fund already holds.
You ignore fees
Your 401(k) is not free. Surprised?
Yes, your employer wants you to save for retirement. That costs money, however.
“Fees can include the costs of buying and selling investments, owning investments and whether or not someone is helping you manage your investments,” said CFP Douglas Boneparth, founder and president of Bone Fide Wealth in New York.
These costs — as much as $467 a year, for example, on a balance of $103,700 — can impact returns. The more you pay in fees, the less you’ll have invested and available to compound over time.
Look at context. Target-date funds, for example, are actively managed and therefore generally more expensive than passively managed index funds. In short, you are paying for a manager to manage an allocation for you. “But in the world of funds, it’s pretty inexpensive,” Fisher said.
You want to time the market
Be wary of the false confidence of those who moved to cash when the market was going down. “That’s only half the story,” Fisher said. “People who get out never know when to get back in.”
In fact, Fisher says, the best rebounds take place after crashes.
Was the market downturn in 2008-2009 scary? Absolutely. Some people pulled out and patted themselves on the back.
“If they never got back in, they missed the whole upside,” Fisher said.
Vanguard found that investors who stayed the course more than regained what they had lost. A hypothetical $50,000 investment in an S&P 500 index fund would have dipped by half in early 2009 and then rebounded to $84,200 by 2015, the fund company showed.
You’re too conservative
Being conservative is an unintended risk for investors, says Loewengart.
Shying away from equities means you’ll have less to spend, because your money won’t outpace inflation.
Even now, in a volatile market, you’ll want to stay invested in equities to some degree.
Sure, it’s unnerving — especially for Millennial and Gen Z investors whose introduction to the market was a 10-year bull run. “The best course of action is to ride through the storm,” Loewengart said, “not to get out of the boat.”
You’re not diversified
As great as it is not to pay taxes right away, you may not want all your invested savings to be tax-deferred.
“The biggest omission, is that if you pay the tax and save [for retirement] in a Roth option, not only is the money you save tax-free, all the growth is tax-free,” Fisher said.
If a 35-year-old saves $10,000 a year and retires at 65, that account will be closer to $1 million with compounding, Fisher says. An upfront tax deduction saves paying tax on $300,000 — but when investing through a Roth 401(k), the entire million is tax-free.
People like the tax deduction today, but there could be a much bigger payoff tomorrow.
Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.
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