O S&P 500 showed incredible growth in the past two years – almost 30% in 2019 followed by about 14% in 2020. To put that in perspective, if you applied these growth rates to a balance of $ 100,000, it would increase to almost $ 150,000 in two years. And that without counting your ongoing contributions. That kind of growth can give you a good push to reach your retirement savings goals.
If you are not seeing these strong growth rates in your retirement account, it is time to find out why. Here are three common reasons why your retirement investments may fall short of the stock market.
1. You are very conservative
Your portfolio may be underperforming because your combination of investments in stocks, bonds and cash is very conservative. Your age is an important factor here, because what is very conservative at 25 may be appropriate at 55.
However, there is an easy formula for checking your allocation. Just subtract your age from 110 – the answer is the percentage of shares you should have in your portfolio. If you are 25, for example, it is appropriate to keep 85% in shares and the rest in bonds and cash. At 55, you would have 55% shares and 55% bonds and cash.
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The beauty of this formula is that it naturally takes you to a smaller percentage of shares over time. This allows you to participate in market-level growth when you’re younger, and then switch to a more conservative asset mix as you get older.
As your portfolio becomes more conservative, you will see lower growth rates. Consider this an intentional underperformance of the market. It isolates you from volatility, which is more difficult to manage when you are receiving retirement distributions or are about to start taking them.
2. You are paying high fees
The administrative fees you pay to mutual funds and your 401 (k) put negative pressure on your returns. If your investments yield a 7% return, but you pay 2% in fees, your real return is 5%.
Research the expense ratios in your mutual funds and ask your 401 (k) administrator for details of plan fees. Mutual fund expense ratios generally range from less than 0.1% to 2.5%. You want to stay below 1% or even 0.5%, if possible. A 401 (k) administrative fee of 1% is quite normal, but 2% or more would be high.
If your 401 (k) charges 2% per year and only offers funds with an expense rate of 1% or more, you have to make some decisions. You could start investing your money elsewhere, but that doesn’t always make sense. You get deferred tax earnings growth on your 401 (k), which is a powerful thing. You can also receive corresponding contributions from the employer. These two features combined may be worth more than what you are missing out on fees.
To get the best of both worlds, you can contribute enough to 401 (k) to maximize your employer correspondence and then send additional contributions to a traditional or Roth IRA if you qualify. You may not get a tax deduction for IRA contributions as you do in 401 (k), but IRAs offer tax-deferred growth.
3. Are you trying to time the market
Even when you have the right mix of assets, trying to adjust time to market can reduce your returns. What usually happens is that you will sell your retirement investments when stock prices are falling – in an effort to limit your losses. But you will not buy back until stock prices are rising, so you are sure that a recovery is underway. These are normal human reactions, but the result is that you sold for less and bought for more. And that is not the way to maximize your returns.
A better approach is to stay in the market in good and bad times. This ensures that you benefit from recovery gains, which can be dramatic and unexpected. More importantly, those days of high growth are also major drivers of long-term returns. A 2019 JP Morgan report found that losing 10 of the best days on the market between 2000 and 2019 would reduce its annual return from 6.06% to 2.44%.
The takeaway? Stay in the market. It is too risky to do the opposite.
Returns make a difference
If you can adjust your retirement portfolio or the way you manage it to improve your returns, do so. Even a small change will help. With a balance of $ 100,000, for example, you will earn $ 35,000 more in 10 years, with 7% growth vs. 5%. Increasing your shareholding, exchanging an expensive mutual fund for a cheaper option, or learning to put blinders on when the market goes crazy are strategies that can help you reach your retirement goals much faster.