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It is often said the definition of insanity is doing the same thing over and over again yet expecting a different result. When it comes to providing for their retirement, many investors have done just that for decades. Even though there is a great deal of research and evidence as to what it takes to have a successful retirement program, too many Americans ignore it and continue with their bad behaviors. Dalbar, the Boston-based research firm for the financial-services industry, reports in their annual quantitative analysis of investor behavior how repeatedly, investors often make the same mistakes. This study assesses how well workers have managed their retirement savings. While the most recent survey indicates a gradual improvement in investor behavior, many Americans still need to make dramatic changes in how they go about investing. While there are a lot of observations in this study, if you just follow four simple recommendations, you will go a long way towards fulfilling your retirement dreams. Their first observation, and probably the most important one to understand, is that investor behavior drives returns. They found that investment returns were far more dependent upon how individual investors behaved rather than on the types of investments that they held. By comparing the returns of the average equity mutual fund investor with the average returns of the S&P 500 over a 20-year period, they showed how bad investor behavior can be detrimental to your portfolio. Over this period the average investor in an equity mutual fund trailed the returns of the S&P 500 by index by 8 percent. By chasing fads, trying to time the stock market and selling out at the wrong time, the average investor has ruined many of his chances to have a successful retirement experience. The conclusions of this study were illuminating. They found that it was much more important not to make a mistake in trading then to pick the right types of mutual funds. Even a fund that only earned 75 percent of the S&P’s return would have beaten the returns earned by the majority of mutual fund investors. Trading and timing errors are so large that holding a substandard fund is preferable for the average investor than trying to out-think the market. However, not many people would pick an equity fund that had these poor results so if you would pick a higher performing fund, or the S&P index, and simply hold it you would have returns better than the vast majority of investors. A second area of the study was to quantify the value of starting an investment program at an early age. We have often heard the mantra to start saving early, but this study made an effort to quantify the advantages of this concept. It was assumed that the average worker had a 45-year career in which to save for their retirement. The historic returns of the stock and bond markets were used and it was assumed that people would invest in a well-diversified, balanced portfolio over their working life. The goal for the exercise was to have enough money saved at the beginning of their retirement that they could fully replace their income with their retirement savings with no change in their lifestyle. The rate of savings necessary to fund these goals varied dramatically with time. If you began your career with a savings rate of 6.6 percent of your annual income, you would adequately fund your retirement needs given their assumptions. This number is very similar to what an employee can defer in a typical 401(k) plan. If you defer 5 percent of your salary and receive a 2 percent match from your employer, you should be adequately protected. This type of deferral is commonly offered but often overlooked by young workers who want that extra bit of cash in their paycheck. That is a big mistake. By waiting just ten years before starting to save, the necessary salary deferral rate now jumps to 11.6 percent of income to achieve the same goal. If you wait 20 years, you will really be behind as you will now need to save 16.6 percent of your income in your attempt to catch up. Over the last decade there has been a large shift in responsibility for retirement savings. The shift has been from the employer – phasing out traditional defined-benefit pension plans – onto the employee, with personal responsibility for their own 401(k) plan. If the current trends keep up there will be almost no company-provided pension plans 40 years from now. Individuals will need a thorough understanding of not only types of investments, but also how much they should be saving. While 401(k) plans have done a decent job offering participants good investment choices, little has been done to ensure that they were saving enough of their income to replace it in retirement. Starting early with their retirement savings program is one of the biggest favors a new worker can do for themselves. Time allows money to compound and gives you the ability to recover from mistakes and market fluctuations. Older workers need to take a realistic assessment of their plan to see if they will have a secure retirement. If there is a shortfall, they will need to make catch up contributions. The first step is to maximize contributions to any deferred plans they might be enrolled in. If this is not adequate to make up the shortfall, then more must be saved out of consumption. Sometimes just by saving all bonuses and salary raises in an account for retirement will be sufficient to fund your retirement. This can be accomplished with almost no change in lifestyle. A third suggestion from the Dalbar study is that a disciplined investment process reduces the risk of failure. A disciplined investment process begins by having a portfolio designed for your needs and risk-tolerance. That is followed by staying with this portfolio over periods of years and giving it a chance to achieve your goals without any capricious changes. Their study suggests that for many investors the easiest way to achieve this discipline is through using an asset allocation fund. Asset-allocation funds usually have either a targeted amount of exposure to various asset classes or sometimes they have a target retirement date. The benefits of these funds lie in the construction and rebalancing. These broadly diversified funds help reduce investor anxiety by having less-volatile moves than many mutual funds. This reduces the chance of panic selling by investors during market declines. Evidenced by the retention rates, the time-period investments are held, it seems clear that asset allocation funds have added a large measure of discipline for average investors. Often, when one class of assets in these allocation funds is falling in price, another one is appreciating. This diversification helps allay fears of investing in the market and provides a measure of comfort during bad periods. A second advantage to these funds is that they offer automatic rebalancing of their holdings. If there has been more appreciation in one asset class than the others, automatic rebalancing will restore the holdings back to the predetermined levels. This rebalancing helps the investor keep on the right track to achieve his goals without taking on more risk then they are comfortable with. This helps enforce the investment discipline and maintain the desired asset mix. The fourth suggestion that we can take from this study is that systematic investing is a path to investment success. Systematic investing is putting a predetermined amount of money into your asset allocation at regular intervals. Often this approach is described as dollar-cost averaging. The idea is that, regardless of whether the market is up or down, you are continuous investors. You are not trying to time your purchases, but you have a method to regularly invest for your future. Remember the average investor who tried to time his mutual fund purchases has lagged the S&P by 8 percent, and this is not what you want for your retirement accounts. Over a simulated 20-year period it was demonstrated that investors who use a dollar cost averaging approach would have ending balances 50 percent higher than an investor who made contributions in the same pattern as the average investor. The easiest way to make this work is through routine salary deferral plans at work. This is why 401(k) plans work so well when you take full advantage of them. They help you make disciplined periodic investments regardless of the state of the markets. If you don’t have a retirement plan at work, get in the habit of writing a check to your investment account every month when you pay your bills and get in the habit of periodic investing. What is very interesting about these four simple suggestions is that not one of them has anything to do with finding higher-performing mutual funds or the next hot stock. You can vastly improve the quality of your retirement savings plan by taking these four steps that are really very simple. Start early in your investing career, be disciplined in your approach, make regular contributions, and avoid bad behavior and you should be well on the course to a secure retirement. William Z. Suplee IV is the president of Structured Asset Management Inc., a financial planning and investment advisory firm located in Paoli, Pa. He may be reached at 610-648-0700 or [email protected].

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