Retirement Portfolio Landmines

Asset allocation, diversification, and rebalancing, also known as Modern Portfolio Theory, have been preached by the Wall Street machine only since about 1990. Has it worked?

Modern Portfolio Theory (MPT) assumes that most of your long-term investment performance will come from how you spread your money between different asset classes (stocks, bonds, etc.), rather than the individual investments that you own. In other words, the details of your actual holdings are not as important as your blend between different asset classes in your pie chart.

Now I want you to stop and ask yourself, “how many wealthy and successful people do I know who have made their millions by ignoring the details of their money and simply taking a shotgun approach and spreading their money all over the globe?” The answer is probably none! The truth is, wealthy people tend to keep a close eye on the details of what they own and the potential risks that they might be exposed to today and in the future. They often pick a handful of well-chosen investments that they understand — and then keep a close watch on potential risks.

This is the exact opposite of Modern Portfolio Theory or what some refer to as “blindfolded pie chart” investing, which is the standard among large banks and brokerage houses who are in the business of selling packaged investment products to consumers. To make matters worse, trillions of dollars per year end up automatically flowing into this “blindfolded pie chart” approach from 401(k) retirement plans where a majority of Americans’ retirement funds dwell.

After more than 25 years, the results are in and they ain’t pretty! Mass acceptance of MPT has left tens of millions of Americans unable to retire. In fact, according to a recent survey by AARP, over 50 percent of people between the ages of 50 and 65 say they believe they will never be able to retire — ever! This is more proof that the MPT experiment sold to Americans by the Wall Street marketing machine has been a complete disaster.

So what can you do if you have a 401(k)? Here are some suggestions for every 401(k) participant: first, request the owner’s manual (prospectus) for the mutual funds that you own inside of your 401(k) and look at what the fund manager is and is not allowed to do with your money so you can decide if you are comfortable with the approach. Focus on the investment policy section and the investment restriction section to find what might be hidden under the surface of your funds. Next, take a look at the examples below of some of the dangers to look out for from my upcoming book “Retirement Portfolio Landmines and How To Avoid Them” and see how your mutual fund holdings fare:

Landmine No. 3: Overlap of Holdings. Even if you are holding multiple funds — with the belief that you are spreading your risk — you might be shocked to find a bunch of your managers own many of the same stocks. Companies like Apple (AAPL), AT&T (T), or Boeing (BA) can be found in many of the top funds. When multiple mutual funds that you own have many of the same top holdings, if any one of these stocks crash, your losses will be multiplied by how many times you hold that position.

Landmine No. 7: Mysterious Outperformance
. When most people see a mutual fund manager consistently outperform their peers, their initial instinct is to put more money into that fund. Remember — Bernie Madoff beat the pack for a couple of decades before anyone questioned him. It’s much more important to ask how a manager is achieving their performance than to ask how much they are making. Often, out-performance equals hidden risk. A market crash is not the time to discover aggressive techniques used by your fund manager to boost returns. Know your mutual funds!

Landmine No. 8: Doubling Down on Your Industry. If you work for a company and you invest into that company stock or others in the same industry, you have effectively doubled down on your risk. If something bad happens like the dot-com bubble bursting in 2000 or the real estate or banking industry crash in 2008, you could lose your paycheck while simultaneously watching your retirement funds crash. If you work in a particular industry and your paycheck depends on it doing well, you already have enough risk and don’t need to add a whole bunch more by having a big chunk of your retirement pie chart in the same industry or company.

Landmine No. 12: Contributing Beyond Your Company Match. Contributing Beyond Your Company Match. Nothing feels better than that “free money” feeling you get when your company matches a portion of your 401(k) contribution. The problem happens when you contribute beyond your company match simply for the purpose of tax-postponement. Unless you are comfortable rolling the dice on what future tax rates will need to be for the U.S. to pay for future obligations, you’re gambling with your future. Taxes today are some of the lowest rates we have seen in 80 years, so it may be risky that future rates will be the same or lower. Also, when you retire, even though you might make less income, many of your best deductions (i.e., mortgage interest, kids, business expenses, and retirement plan contributions) will be gone and the idea of lower rates may be a pipe dream. There may be no time like the present to pay historically low tax rates and seek alternative investments that grow tax-free for the future.

There is so much to consider when it comes to retirement planning, and there are so many pitfalls to avoid. From knowing how much to save for retirement to investment management, Brian Britt at CLEARWEALTH Asset Management can help. Contact us today for help with a variety of financial services or to attend a retirement planning course.