Here’s what we cover in this episode:
⚖️ Misaligned Risk: Balancing your portfolio’s risk with your goals and time horizon
💵 Yield vs. Return: Why focusing only on income can limit long-term growth
🧠 Market Discipline: Why guessing or timing the market rarely works
🔥 Chasing the Hot Stocks: The danger of following trends instead of fundamentals
Executive Summary:
Here’s a football metaphor. It may be exciting to see a quarterback hurl the ball down the field for a long touchdown but constantly attempting that high-risk throw will almost certainly lead to more interceptions than more disciplined offensive play calling.
Which would you prefer for your hard-earned nest egg: an “exciting,” high-risk gamble or a repeatable process rooted in time-tested principles? This post outlines seven common investment mistakes and our recommended fixes.
1. Holding Excessive Cash
Everyone needs a cash emergency fund, but hoarding a mountain of cash is a major investing mistake. Cash feels safe because the value doesn’t fluctuate. But cash is riskier than you might think. It struggles to maintain purchasing power over long periods—especially after taxes.
This means your cash will generally either be treading water or losing purchasing power over time (meaning the same amount of cash will buy fewer goods and services in the future). Stock market risk tends to grab our attention, but inflation is often a steady, silent killer of retirement plans.
Fix: Hold enough cash for an emergency reserve (three to six months of living expenses) plus any large, planned purchases (second homes, remodeling expenses, new cars) expected in the next few years. Invest your remaining assets in a portfolio properly calibrated to your financial goals and personal risk tolerance.
2. Portfolio Takes Too Much Risk (Or Not Enough)
Your portfolio’s risk level and required rate of return must align with your time horizon and spending needs in retirement. This mistake comes in two flavors:
- Too Little Risk: An investment portfolio with too little risk is like an underpowered engine. It may not have enough juice to support your spending goals. At 3% inflation, prices will double in 23.5 years. Many investors will spend 20-30 years in retirement, if not longer!
- Too Much Risk: Risky portfolios are most vulnerable during periods of large withdrawals, and at the transition into retirement. A market crash in a vulnerable period can destroy a retirement plan.
Fix: Be mindful of the risk you’re taking, especially during transitional periods. Your portfolio should be designed to generate the return you need to maintain your lifestyle without exposing you to unnecessary risk.
3. Ignoring Sequence of Returns Risk
When you are withdrawing money from a portfolio, the order of your returns matters. In retirement, the first 10 years of portfolio performance often determine success or failure.
Two retirement portfolios with the same total return can have very different results, depending on when the bad returns show up. All else equal; the portfolio that experiences bad returns earlier in retirement will have a worse result. The difference can be in the hundreds of thousands of dollars.
The challenge is that you can’t time the market. You may also have limited control over your retirement timeline.
Fix: Proactively reduce portfolio risk several years prior to retirement. Build a balanced portfolio of stocks, bonds, and cash. Design your plan to be defensive, ensuring you are not forced to sell stocks at low prices during a bear market.
At Wyze, our strategies aim to first generate income from dividends and interest. If additional funds are needed, we sell appreciated assets (stocks) when markets are running high and draw from safer assets (cash/bonds) when markets are down.
4. Focusing on Yield, Not Total Return
Yield chasing—focusing exclusively on high dividend stocks or high-yield bonds while neglecting total return (income plus capital appreciation)—is a dangerous game. Over the years, we’ve learned that this usually stems from a desire to maximize a retirement income stream.
Potential issues include:
- Unsustainability: A very high yield can actually signal something is fundamentally wrong with an investment. Yields can increase when payouts increase but also when prices fall. A very high dividend yield on a rapidly falling stock is what’s called a dividend trap. Our post on dividend investing contains more information on dividend sustainability and why high yields can be misleading.
- Ignoring Appreciation: Many high-appreciation stocks don’t have high dividend yields (these companies are reinvesting their cash rather than paying it out). By only focusing on yield, you may be missing out on significant capital growth opportunities.
- Tax Inefficiency: Taxes reduce returns. It’s that simple. If you are chasing yield in a non-retirement account, you may be unpleasantly surprised if you ever calculate your after-tax returns. When possible, we focus on placing tax-inefficient investments in IRA accounts and tax-efficient investments in non-retirement accounts. This is a great way to make sure your money is working for you, not Uncle Sam.
Fix: View return as coming from two sources: income and capital appreciation. Focus on total return. Own assets in account types suited to their tax and return profiles.
5. Failing to Systematically Rebalance
Setting your portfolio and forgetting it when you are nearing retirement is a mistake. If your 60% stock/40% bond portfolio sees a huge run-up in the stock market, it may turn into an 80% stock portfolio! This then leaves you exposed to far more risk if the market crashes.
Fix: Rebalancing must be a systematic, rules-based process—not based on emotion or “feel.” The goal is to return the portfolio to its target allocation before things get dangerously out of whack. This involves selling assets that have become expensive (run up in price) and buying assets that have become cheaper (come down in price).
Studies show you should look at the portfolio frequently, but only trade when the allocation deviates meaningfully from its targets. More volatile assets should have wider tolerance bands (stocks should be allowed to fluctuate a bit more than bonds). Systematic rebalancing helps smooth returns throughout retirement.
6. Market Timing Based on Opinion
Market timing—trying to predict short-term movements based on news or opinion—is extremely difficult. We don’t believe it’s possible to get these calls right consistently. Still, we understand the appeal. We’d all like to be able to sell right before market crashes and buy right as markets bottom out.
The problem is emotions tend to drive market timing decisions. When markets fall, we lose money and we feel pain. Our primitive instincts send us into fight-or-flight mode. Make the pain stop! These same instincts then keep us out of the market until it’s “all clear.” The problem is it doesn’t “feel” all clear until the market recovers significantly… just in time for the next crash…
This emotional cycle of “buying high” and “selling low” is a long-term wealth destroyer. Studies show that when you market time, you need to get your timing right on both sides (selling and buying) about 70% of the time. We don’t like those odds. And we do this professionally.
Fix: At the risk of sounding like a broken record, this comes back to having a disciplined approach and a balanced portfolio (stocks, bonds, cash). Don’t obsess over all-or-nothing market calls.
At Wyze, we utilize a proprietary All-Season Asset Allocation Framework to balance portfolios across the full range of economic environments. We aim to smooth portfolio returns over the entire market cycle. Our allocations are designed similarly to all-season tires built to handle rain, shine, sleet or snow.
7. Chasing Hot Investments
Investors are often driven to chase investments after massive runups in price. The reason is simple: fear of missing out (“FOMO”). If something has gone up 5x, better jump on the train before you miss the next 10x or 100x move up!
The problem is that the top dogs tend not to stay on top for very long. A study looking at the top 10 most valuable companies every 10 years found that on average, only 2 of 10 carried over from one decade to the next. Chasing hot stocks tends to lead to another vicious cycle of buying high and selling low.
There are a few reasons we tend to overestimate the staying-power of popular stocks:
- Competition: High growth and profitability attract competition, which slows the original company’s growth and pressures its profitability.
- Innovation: New companies can displace old ones with better products and service (think of Apple disrupting Blackberry).
- High Valuation: Popular stocks can become so expensive that future above-average returns are very difficult to achieve. For example, Cisco’s price-to-earnings ratio hit 130x in 2000 (historically the US market averages about 15x–17.5x earnings). Cisco stock barely moved for the next 20–25 years while earnings caught up to that price.
Authors:
Ryan Wyatt, CFP®, CIMA®
Nick Lewandowski, CFA®, CFP®
Resources:
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This communication is provided by Wyze Wealth Advisors LLC, a registered investment adviser. All material is for informational and educational purposes only and should not be considered personalized investment advice or a recommendation regarding any specific security, strategy, or product.
The assumptions and scenarios presented are illustrative and do not reflect actual investment results. Projections are based on current market conditions, which may change. Past performance is not indicative of, and does not guarantee, future results. All investments involve risk, including the potential loss of principal.
Investment decisions should be made based on an individual’s objectives, risk tolerance, time horizon, and financial circumstances. Additional information about our services, fees, and Form ADV Part 2A is available upon request.
