What Investors Don’t Know Can Cost Them
March 28th, 2019 | 4 min. read
Benjamin Franklin famously said: “An investment in knowledge pays the best interest.” Another way to put it would be to say, An indifference to ignorance charges the most interest.
Numerous studies appear to back this up. They show that many investors make costly mistakes or miss rewarding opportunities simply from a lack of understanding about essential components of investing.
In other words, ignorance is expensive. Here are some things investors may not know, according to research, and how they can affect your chances at achieving your financial goals.
How should I save and invest for retirement?
For most people, the years before retirement are not filled with elated feelings of anticipation, but rather anxiety. Of those who are 11-15 years from retirement, 75% say they feel stressed when thinking about their retirement savings and investments, according to Franklin Templeton’s 2018 Retirement Income Strategies and Expectations (RISE) survey.
The survey found a key contributor to feelings of stress about retirement income is “a lack of understanding” regarding important retirement planning decisions. Nearly 60% of those aged 45-54 said they “don’t know” how much of their income will be replaced by the funds in their workplace retirement plans; 47% were unsure how much of their retirement savings they should expect to withdraw or spend in retirement; and 56% couldn’t say how much of their income would be replaced by Social Security.
Without these important details, it’s difficult to appropriately manage your retirement savings and investments. You could fail to save enough money to last throughout retirement – or to even retire.
This reinforces the benefits of having a plan. Of those who developed a written retirement plan, according to the survey, 84% had a retirement income strategy that could last 30 years or more and 86% were certain as to how they will pay for medical expenses in retirement. Further, 93% were “confident” and/or “happy” with it. And, of all respondents, 54% of those with a plan feel stressed compared to 71% of those without a plan.
Similarly, a report from Charles Schwab found people who have a written financial plan are far better off financially than those without a plan. Among people who have a plan, 75% pay bills and save each month compared to 33% of those without a plan. Also, 65% of planners have an emergency fund compared to only 24% of non-planners. That explains why 62% of planners said they feel financially secure while only 32% of non-planners could say the same.
Do I need a financial plan?
Even with all the benefits of a financial plan known, only one in four Americans have one, according to Schwab. When asked why, 45% of respondents said they don’t have a financial plan because they assume they don’t have enough money to merit a plan. Meanwhile, 20% said they just don’t know how to get a financial plan.
A common misconception is that financial plans are only for millionaires. In truth, anyone can get – and would benefit from – a financial plan. It just comes down to finding the right financial adviser for your situation. The alternative is to expect to miss your financial goals.
What investments should I choose?
Research shows many retirement investors are unsure as to what investments they should choose. A Federal Reserve report found 60% of pre-retirees with retirement savings accounts, such as a 401(k) or IRA, are uncomfortable making investment decisions.
Of course, choosing the wrong investments will undoubtedly impact your returns. Over time, a small difference in return could be the difference in living a comfortable retirement. For example, let’s say you save 15% of a $55,000 salary over a 35-year career. The difference in ending balances in a retirement savings account when earing 3% versus 6.5% in annual returns would be $498,812 and $1,023,286, respectively. That’s a difference of $524,474.
Unfortunately, investors often make investment decisions based on their emotions, which affects their performance. A study by market research firm Dalbar found the average investor’s annual return over the past 20 years was 5.3% compared to the broader stock market’s gain of 7.2%. Instead of sticking with an investment plan, the average investor tends to either chase returns by choosing funds that have recently performed best, or fearfully exiting the stock market at the wrong time.
This is a key area where financial advisers can help guide and inform investors. According to a report on another Charles Schwab study, the company found “self-directed clients who have help from a financial advisor are more fully invested, better diversified and on average have a higher account balance when compared to investors who do it all by themselves.”
Does my adviser always act in my best interest?
In a survey from Personal Capital, 48% of investors believed that all financial advisers were legally required to always act in the best interest of their clients. Further, 65% of those investors who worked with an adviser believed that all financial advisers only made recommendations that were in a client’s best interest.
Both beliefs are untrue.
Knowing whether or not an adviser will act in your best interest comes down to how that person is registered. Registered investment advisors, such as Advance Capital Management, are regulated under the Investment Advisors Act of 1940. This act bounds RIAs to the fiduciary, or “trust,” standard, which is the highest legal standard. A fiduciary adviser is someone who manages a person’s assets on their behalf and solely in their best interest.
Not all financial professionals are RIAs, and, subsequently, not all financial professionals work under the fiduciary standard.
Registered representatives, such as stockbrokers and advisers working for insurance firms, follow the “suitability” standard. The suitability standard does not require advisers to put their clients’ interests first. It’s possible that they recommend investments from which they receive the highest commissions. Therefore, it’s important to be aware that the advice you receive from one adviser to the next can differ depending on how they are registered.
How much do I pay in fees and how is my financial adviser compensated?
The Personal Capital report also found that only 44% of investors knew how much they paid in investment fees while 20% didn’t know how their financial adviser was compensated.
The more you pay in fees, the less of your return you get to keep. That’s less money you have in your portfolio compounding and building wealth. An investor with a $25,000 portfolio balance earning an average 7% return paying 0.5% in fees can expect it to grow to $227,000 in 35 years. If that same investor paid 1.5% in fees, the balance would grow to only $163,000. Just a 1% difference in fees reduces the ending portfolio by $64,000.
Advisers can be compensated for their services in different ways. Some charge a flat dollar amount or a percentage of assets under management. Others are compensated by the investments they sell in the form of commissions and 12b-1 fees. This is an important difference. It’s better to have an adviser who is compensated for the work done for you and not for the investments sold. And, an adviser who is transparent in how they are compensated. According to a Personal Capital study on fees, an investor could end up paying more than $400,000 in hidden fees over his or her lifetime.
What you don’t know, may not hurt you. But, as an investor, what you don’t know is highly likely to cost you.