Whenever I have given investment presentations in workplace retirement settings over the past two decades the two most asked questions I’ve received are: “Excuse me, sir, where’s the restroom?” and “Where should I put my money?”
The first question has been easy to answer: “Take the elevator to the 4th floor, pass the receptionist’s desk and it’s the second door on your right.”
But the second question – Where should I put my money? – has been a bit more difficult, even with the advent and general acceptance of target-date retirement investments among 401(k) and 403(b) retirement plans. This question reminds me of the Cheshire Cat’s dilemma with Alice in Lewis Carroll’s Alice in Wonderland
. When Alice asked the cat which road she should take, the cat replied, “Where do you want to go?” Alice answered, “I don’t know.” “Then,” said the cat, “it really doesn’t matter, does it?”
As I read between the lines, what Alice really wanted from the cat was some kind of backstop insight – such as, “You really don’t want to end up there,” or “Here’s something you might want to think about” – to help her avoid a poor decision or an undesirable outcome.
The process of picking investments for savings goals can be unnerving. Just the thought of investing hard-earned money in something that is volatile, like stocks or bonds, stops people in their tracks. Have you ever looked at investment choices and wondered “Which way should I go?” If so, here are three tips that can help you think through your options and serve as backstops.
Keep close track of your money.
In the late 19th century, Lewis Carroll did not keep close tabs on his money. According to the BBC
, the author was not parsimonious with his money and regularly received overdraft notices from his bank. Fast forward to today, and cash flow remains a common concern for folks. According to PwC’s 2019 Employee Financial Wellness Survey
, nearly half of American workers say they are worried about meeting their monthly household expenses.
If you are thinking about investing some of your extra income, ask yourself: If your monthly cash flow became tight or an emergency arose, do you have other resources (e.g., a bank savings or money market account) you can access quickly to pay the bills? Fidelity’s 2019 Total Well-Being Survey
found that nearly four out of 10 retirement-plan participants did not have at least three months’ worth of income set aside for an unplanned expense.
To develop this concept a bit further, a good rule-of-thumb is to have at least 6 months’ worth of fixed expenses set aside for an emergency. My fellow CFP Board Ambassador, Douglas Boneparth, CFP®, cleverly calls this process “earning the right to invest.” Once you have a clear understanding of your monthly cash flow and a back-up plan for an untimely bump in the road, then you can approach your investment journey with confidence.
Count the cost of investing.
There is a cost associated with investing your money in the market, whether it’s through a payroll contribution to a workplace retirement plan or a deposit into a personal investment account outside the plan. By investing, you have exchanged the use of these dollars now for a better purpose later on down the road (delayed consumption). What is the better purpose
for your invested dollars? It varies for each person. Is your better purpose the peace of mind that you can retire at a specific age
? Or is your better purpose the ability to send your child to college without having to take out a student loan?
Now, here’s the flip side of the coin: What’s the price tag for your better purpose
? Your better purpose matters, so once you identify how much it will cost you, you can then sidestep the awkwardness of the Cheshire-Cat-moment altogether – that is, you’ll know where you really
want to go, and what it will take to get there.
Learn from others’ mistakes.
In our example with Alice, what strikes me about her character is that she had the self-awareness to ask for input about her journey and the willingness to learn from new information. This stands in stark contrast to the pervasive overconfidence that behavioral scientists say is common in our daily experience.
Here’s what I mean: Despite the fact that 90 percent of car crashes are caused by human error, AAA found in a recent study
that nearly three-quarters of Americans (a whopping 73%) consider themselves above-average drivers. Overconfidence also shows up in investor behavior when emotions – and sometimes a false sense of control – can interfere with sound investment decisions. For example, despite the fact that the broad U.S. stock market (S&P 500) gained an average of 5.62% in the last 20 years (December 31, 1998 – December 31, 2018), the average equity investor
only earned 3.88% according to research conducted by DALBAR, a financial research firm. What this investment gap of 1.74% means for a workplace retirement-plan participant who started with a balance of $100,000 in this period (expenses not included), is that they are missing out on $84,344 in earnings. It also serves as a backstop warning that trying to time the market usually does not pay off in the long run.
Picking the best investments for your savings goals can be tricky, and you don’t have to work through this process alone. If you would like to learn more about how your investments can align with your overall financial plan, reach out to a CFP® professional in your area