A retirement is probably the single largest and most valuable purchase most people will make in their lives, and — fortunately or unfortunately — you generally can’t take out a mortgage or a loan to finance it. This is why those who find themselves well-positioned for comfortable living come the age of retirement are generally the same people who, at the beginning of their working tenure, formed a retirement plan and faithfully executed it.
That is no small task. Nearly half of working-age American households have nothing or next to nothing saved for retirement. As John Bogle, founder of the Vanguard Group, has observed, the three pillars of the American retirement system — Social Security, the defined-benefit plan, and the defined-contribution plan — are all in terrible shape. In a 2012 report, Senator Tom Harkin (D-Iowa) observed that Americans are running a collective retirement deficit of $6.6 trillion.
The purchase that may be the largest and most valuable in the lives of many Americans is out of their reach, and not for the want of trying. Some Americans who form a competent retirement plan still fail to find themselves where they wanted come the age of retirement. Here are a few common pit falls.
1. Being over concentrated
If you’re like most people, you’ve had at least one daydream about how life would be different if you had invested heavily with Google at its IPO or in Whole Foods at the post-crisis trough, when each stock was trading at less than a tenth of its current price. The growth of those stocks has made many people rich — but, unfortunately, probably not you.
This is okay. Few people have the stomach for stock picking and even fewer people should tolerate the risk of investing heavily in any single stock. Instead, most professionals advise that investors diversify and focus on investing in index funds. What you want, as Warren Buffett has argued, is to own a broad slice of the productive, wealth-generating assets that have publicly traded equity. That way, you are making a fairly safe bet on the welfare of the whole system instead of dubious bets on the success of individual parts.
2. Making esoteric investments
There’s nothing like a hunger for yield to trap an investor. When the market is hot, everybody is pushing the next big stock that you should pile cash into (see pitfall No. 1), and when the market is slow, those same people can be found pushing dubious esoteric investments. Common traps include Ponzi schemes, pump-and-dump stocks, or derivatives with opaque components.
Remember — you don’t have to be a genius to invest well, but you do need to be informed. Stay within your circle of competence and make sure you understand what it is you’re getting into.