Sometimes we think we're doing everything right, yet we fail to achieve our goals. If you've noticed that your investment returns are falling short of your expectations, it might not be the market's fault. One of these four reasons could be the true culprit.
Paying Yourself Last
If you don't make saving and investing a priority, your account balance will never grow. Paying yourself first means that once a month, or each time you get a paycheck, you set aside a portion of that money for your own savings before you pay any bills or buy anything.
But what if you only have a limited amount of money coming in each month and still have bills to pay? Regardless of when you set aside money for savings, there's only so much you can set aside, right? How can paying yourself first possibly work if you're strapped for cash?
It sounds crazy, but paying yourself first works. The money disappears from your account almost before you know it's there, and once the money's gone, you can't spend it. Whatever frivolous expense you might have wasted the money on, you'll no longer have the option to purchase. You might have to be creative with the money you have, in order to scrape by until your next paycheck, but you'll be surprised at what you can come up with when you have to.
Clearly, it doesn't make sense to pay yourself first if you have to default on a credit card payment or incur another expensive consequence to do it. Your pay-yourself-first amount needs to be an amount you can afford every month. If that amount is too small to help you meet your investing goals, then any time you get extra money, put a small percentage into savings before you're allowed to spend anything.
The best way to accomplish paying yourself first is to automate it - set up the transfer so your bank does it each month or each paycheck, with no further action required on your part. Also, transfer the money to a place where it's hard to cash out. Don't just transfer the money to a savings account at the same bank where you have a checking account; it's too easy to move that money back into checking the moment you feel like you need it. Transfer the money into your retirement account or into a certificate of deposit. This way, you'll have to pay a penalty to get the money back and you'll be more likely to keep it in savings, where it belongs.
Not Maxing out Tax-Advantaged Accounts
Taxes take a significant chunk out of your investment gains when you invest through regular, taxable accounts. When you invest through tax-advantaged accounts like IRAs and 401(k)s, your gains grow tax free. Because of the power of compound growth, your investments can grow dramatically faster in tax-free accounts. If you're not maxing out these accounts and you're putting some of your money in taxable accounts, shift some or all of those investment funds to the tax-advantaged accounts and watch your money grow faster.
Suppose you currently have $10,000 invested in a stock index fund and you're contributing $250 a month. After 30 years at an 8% rate of growth, you'd have $280,233 if you invested in a regular, taxable account; but you'd have $452,764 if you invested in a tax-advantaged account. Use an online calculator like Bankrate's Investment Goals Calculator to see how much your investments could earn under different circumstances.
Paying Too Many Investment Fees
Depending on the types of investments you choose and the brokerage through which you buy, sell and hold those investments, you could pay next to nothing in investment fees or enough to seriously drag down your returns. Here are two common places where fees could be eating into your returns:
401(k) accounts - 401(k)s often have limited investment options and those options sometimes have higher fees than what you'd pay for a comparable investment, if you could shop around. If this is the case with your 401(k), you may want to contribute the minimum amount to get your employer's match (if any) and stash the rest of your savings in a Roth IRA, where you'll have full control over your investment fees. Within your 401(k), choose the lowest-fee options that match your investing goals. Remember that you can achieve diversification across a number of accounts, so if the 401(k) only has a high-fee international fund option, skip it and invest in an international fund through your Roth.
Frequent trading - For many investments, you have to pay a commission each time you buy and each time you sell. Buying and selling frequently, instead of buying and holding, can get expensive, even if you're only paying $8 per trade. Before you place a trade, look at what percentage of your investment you're losing from the commission. If you're paying $8 to sell $80 in stock, you're taking a 10% loss. Is it worth it?
One way to minimize your fees is to open an account with a brokerage, like Fidelity or Vanguard, that offers a wide range of investment options with no commissions and low fees.
Buying High and Selling Low
If you want to meet your investment goals, you need to take emotion out of the process. It's incredibly tempting to buy an investment when it's on the upswing and everyone is excited about how well it's performing. However, if you buy at times like this, you're likely to overpay. If you're still holding your investment when the party stops, you lose, especially if you sell rather than waiting for a rebound. Think of these swings in the stock market like the housing bubble – would you rather have bought in 2005 or in 2012?
There are two good ways to counteract these emotional tendencies. One is to buy a diversified index fund or exchange-traded fund (with low fees and no commissions, of course) periodically throughout the year, so that you're not strongly affected by high and low points in the market. Another is to learn the art of value investing, which preaches the evaluation of a stock's fundamentals and buying when a stock is trading at two-thirds or less of its fundamental value – in other words, when it's unpopular, but the underlying company is still a good bet.
The Bottom Line
It's easy to blame the market for an underperforming portfolio - and sometimes the market truly is to blame - but a series of small human errors based on bad habits, inattention or emotion can also preclude achieving your goals. Even if you think these four concepts are firmly ingrained, examine your portfolio statements and make sure you're not accidentally putting these bad behaviors into practice. If these concepts are new to you, you may have found some easy solutions to a seemingly mysterious problem.