When I was 23 years old, my employer decided to change their pension retirement system to a 401k. I received the letter from Human Resources instructing me to attend the meeting with the financial advisors who were going to help me set up my new 401k. I was excited that I was finally well on my way to financial independence and that after this meeting, I would have all the tools to become the first millionaire in my family.
Being a naive young man fresh out of the Marine Corps, I was taken aback when I entered the meeting and saw approximately 50 other employees waiting patiently for the advisors to begin. I honestly believed that I was going to get one-on-one advice from my financial advisor. Throughout the entire presentation, I remember thinking something didn’t feel right. They walked us through the paperwork and had us take a four-question quiz to determine what type of investor we were. In the end, I noticed nurses, doctors, security guards, and every other employee asking each other what they should do. This was my first experience with the herd mentality.
A few years later, I started working for a large investment firm and noticed that people were still following that herd mentality. Friends were investing in funds based on hot tips from other friends, and advisors were recommending other funds based on what their advisor friends were recommending to their clients. Since I’ve been an advisor, I’ve experienced three major market corrections and noticed throughout those turbulent times people were still following the herd. People ran from the markets at the lows and surged to the markets during highs. It amazed me at how people instinctively did things that were almost always counterproductive for their account— all because they saw other people doing the same thing.
When I started my own firm in 2008, I realized I needed to help my clients avoid this herd mentality. I knew that it wasn’t going to be easy, but after nearly a decade of watching people make the same mistakes over and over I decided to start educating them on the psychology of investing.
Here are few things pointers to avoid getting caught up in the herd:
1. Dollar cost average
This is so important it needs to be repeated. Dollar Cost Average!!! Simply put, it’s the act of contributing into your retirement account on a set frequency. It could be monthly, bi-weekly, etc. This allows you to buy shares consistently over time. This frequency allows for a greater potential at a lower average cost per share.
2. Make a plan and stick with it
Work with your advisor to determine the investment strategy that will work based on your needs. If your plan is properly designed in the years prior to retirement, even a major correction should only have a minimal effect on your retirement nest egg.
The old saying, “If you fail to plan, you are planning to fail” really hits home here. A 61 year old who is invested 100% in small cap stocks who is planning on retiring next year might not have the best plan. It’s important that as you near retirement you stack your portfolio so it can minimize potential loses should the markets correct.
3. Finally the most important…. Don’t listen to friends/news/co-workers/etc.
This is the most common issue with the average investor. The best advice I give my clients is to focus on the plan in place. If you have communicated with your advisor, your allocation should match the time horizon for your retirement. There is no need to follow the herd in fear of loss if you’ve prepared your plan accordingly and limited or completely protected your retirement account from a possible market correction.
Over the past 16 years, I’ve seen family, friends, clients and co-workers all fall into this herd mentality and, unfortunately, their retirement accounts paid the price. There is one constant with the markets and that is they have been consistently increasing for nearly 200 years. The problem lies when the correction falls within the window of a person’s retirement. This is what happened to the majority of investors in 2008 and 2009. Most had a decision to make, and it was either retire and begin living off assets that took anywhere from a 20%– 50% loss of value or wait it out until the market recovered. Having a plan that limits the risk of your principal the closer you get to retirement helps you avoid following the crowd when the markets are in free fall.
To summarize, I tell all my clients the same things: We must communicate with each other on investment goals, develop a plan, monitor those goals, change the plan as needed, and ignore investment advice from people who don’t share your same goals. There is no way to avoid risk completely, but having an active relationship with your advisor and building a plan can help you avoid the mistakes that lead most investors to follow the herd of other scared investors into a series of bad and emotional decisions.
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