It’s never too early to save for retirement, but according to a recent CNBC report, some young investors may be losing money due to common (and avoidable) investing mistakes.
At Addition Financial, we spend a lot of time talking to our youngest members about the importance of investing early. What we’ve found is that the fear of making mistakes sometimes holds people back from getting into the investment habit.
With that in mind, let’s talk about some of the mistakes identified in the CNBC report and what you can do to avoid them.
Mistake #1: Not Taking Enough Risk
The first mistake is a common one among young people who are new to investing. There is always some risk involved in buying stocks, but it’s a risk that’s worth taking. The potential reward of investing in the stock market is far higher than it is with other types of investments.
A good rule of thumb is to subtract your age from 110 or 120 to decide how much of your savings to put in the stock market – or, if you are nervous about putting all your assets into the stock market, subtract your age from 100 instead. That means if you’re 20, you should be putting a minimum of 80% of your savings into the stock market.
Mistake #2: Deferring All Taxes
If you put your money into a traditional IRA or an employer-sponsored 401(k) plan, then you can contribute pre-tax dollars. That means a bigger investment up front – however, it also means you might end up paying a high tax rate when you withdraw the money.
Your best bet is to invest some of your post-tax earnings in a Roth IRA now. You’re still investing early and when you withdraw from the IRA, you will not need to pay taxes on your initial investment, or – and this is important – your earnings.
Mistake #3: Not Diversifying Your Investments
One of the most common investing mistakes people make is not paying attention to their asset allocation. It’s the financial equivalent of not putting all your eggs into one basket. If too much of your savings are in one investment, your risk of sustaining a big loss is higher than it needs to be.
The solution is to review your investments regularly and reallocate your assets as needed. Alternatively, you could invest in an exchange-traded fund or a target-date fund, which has built-in diversification.
Mistake #4: Panicking During a Market Downturn
It’s understandable to feel some anxiety when there’s a big market downturn. If a sizable percentage of your investment is in the stock market, then you might – on paper – lose money when the market takes a hit.
That said, it’s a mistake to panic and sell your stocks when prices are low. According to CNBC, the market typically experiences its largest growth in the aftermath of a downturn. Investors who pulled out of the market after the financial crisis of 2007/2008 missed out on the expansive growth that followed it.
The solution is to take a deep breath and keep your investments where they are. When you’re young, you still have plenty of time for the stocks you own to recoup their losses. (That said, older people who are close to retirement might not have the same luxury.)
Mistake #5: Ignoring Investment Fees
The final mistake is one that’s easy to overlook because the fees for investment accounts are small compared to the average balance. However, paying several hundred dollars in fees every year can and will reduce the amount of money you have available to invest.
That said, some fees are worth paying. For example, target-date funds charge fees to cover the expense of managing the fund and ensuring that investors have the right mix of investments. By contract, passively managed index funds cost less.
The solution is to read the fine print and make sure you understand what you’re paying for. You can then weigh the risk and reward associated with the fund and make an informed decision.
Investing early is important because it gives you the best possible chance of accumulating the money you need to have a comfortable retirement. If you can avoid these common investing mistakes, you’ll be off to a great start!
Need some help with managing your money? Click here to read about Addition Financial’s Investment Services for members!
