The S&P 500 has shown incredible growth over the past two years – almost 30% in 2019 followed by about 14% in 2020. To put this in perspective, if you apply the growth rates to a balance of $ 100,000, it will fall to $ 150,000 in two short growth years. And this is without justifying your current contributions. That growth can give you a good push to reach your retirement savings goals.
However, if you do not see the strong growth rates in your retirement account, it is time to find out why. Here are three common reasons why your retirement investments may slow down the stock market.
1. You are too conservative
Your portfolio may be underperforming because your mix of investments in equities, bonds and cash is too conservative. Your age is an important factor here, because what’s too conservative at age 25 may be just right at age 55.
However, there is an easy formula to check your award. Simply subtract your age from 110 – the answer is the percentage of shares you should have in your portfolio. For example, if you are 25, it is appropriate to hold 85% shares and the rest in bonds and cash. At 55 you have 55% shares and 55% bonds and cash.
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The beauty of this formula is that it naturally leads to a lower percentage of shareholding over time. It allows you to participate in market-level growth when you are younger, and then make a more conservative asset mix after an older age.
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 harder to manage if you are taking retirement benefits or if you are going to start them.
2. You pay high fees
The administrative fees you pay to mutual funds and to your 401 (k) put negative pressure on your returns. If your investments earn 7% returns, but you pay out 2% fees, your real return is 5%.
Look at the cost ratios of your mutual funds and ask your 401 (k) administrator for a breakdown of your plan fees. Ratios between investment funds usually range from less than 0.1% to 2.5%. You want to stay below 1% or even 0.5%, if possible. An administrative fee of 401 (k) of 1% is fairly normal, but 2% or more would be high.
If you charge 401 (k) 2% per annum and only offer funds with a cost ratio of 1% or more, you have to decide. You can start investing your money elsewhere, but it does not always make sense. You get tax revenue earnings in your 401 (k), which is a powerful thing. You can also receive contributions that match employers. These two features together can be worth more than you lose in fees.
To get the best of both worlds, you can contribute enough to the 401 (k) to maximize your employer match and then send additional contributions to a traditional or Roth IRA if you qualify. You may not receive a tax deduction for the IRA contributions as in the 401 (k), but IRAs do offer tax-deferred growth.
3. You are trying to determine the market
Even if you have the right mix of assets, you can reduce returns if you try to end the market. What often happens is that you sell your retirement investments when stock prices fall, in an effort to limit your losses. But then you will first buy in again before the stock prices rise, so you trust that a recovery is underway. These are normal human reactions, but the result is that you have sold less and bought more. And this is not the way to maximize your returns.
A better approach is to stay in the market through good and bad times. This ensures that you can benefit from recovery gains, which can be steep and unexpected. More importantly, those big growth days are also the biggest driver for long-term returns. A 2019 JP Morgan report found that missing ten of the best days in the market between 2000 and 2019 would reduce your annual return from 6.06% to 2.44%.
The takeaway? Stay in the market. It’s too risky to do otherwise.
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 can help. On a $ 100,000 balance, for example, you earn $ 35,000 more within 7 years with 7% growth versus 5%. Increasing your stock, swapping an expensive investment fund for a cheaper option, or learning to use blinds when the market expires are strategies that can help you reach your retirement goals faster.