The Pension Research Council at the Wharton School recently released research indicating that people allow their peers to influence their 401(k) investing. According to the study, 401(k) investors tend to increase their equities allocations when co-workers are experiencing good returns and decrease them when co-workers lose money.
This behavior is part of a larger investing phenomenon commonly called herd mentality. Our ancestors survived by adopting a herd mentality. They stuck together because there was safety in numbers.
Our common desire to follow the herd and stick together is a carryover from days long passed, but the herd isn’t safer when it comes to retirement investing. Actually, your retirement saving and investing strategy should be personalized beyond any need to think about your co-workers’ investment returns.
Why? If Susan with the window office and Larry from two cubicles over are seeing good returns, why shouldn’t you jump to follow their lead?
Reacting to others’ portfolios is akin to reacting to short-term market fluctuations. In both instances, you’re allowing recent events, rather than the big picture, to dictate investing decisions. And being reactionary has not, historically, worked well for investors.
Chasing returns means you’re moving your money into an investment, sector, or asset class that performed well during the previous period without researching how it’s likely to perform in the coming months. In fact, moving into an investment that’s already been performing well means you’re probably buying high and hoping it goes higher.
This is a risky endeavor. You’re relying on your retirement savings to allow you to live comfortably when you can no longer work—or don’t want to. Retirement investors should take a long-term view to guard and protect their nest eggs. Don’t be concerned about co-workers’ returns or one day’s market performance.
Because retirement investing is a long-term activity, it requires some patience. Here are steps you can take to help stay focused on your personal objectives:
Think about how you want your retirement to look. Be realistic. Where do you plan to live? What do you want to do with your time? At what age do you plan to retire? What might you want to buy? What living expenses will you have? How will your health history affect your retirement spending?
Decide how much money you’ll likely need to cover the costs you anticipate during retirement. If your goals and expectations are unrealistic, either adjust them or find a way to save more money.
Determine your tolerance for investment risk. Risk tolerance is a personality trait. It may change as you change as a person, but it shouldn’t change because the market is doing better or worse.
Choose an appropriate asset class allocation to suit your situation. Diversifying your portfolio into several asset classes is instrumental in decreasing your overall risk, but the percentage of your money you allocate to a given asset class will vary depending upon your risk tolerance, time line to retirement, investing biases, and the current economic conditions.
Choose the funds within your 401(k) that best match your allocation. Be sure to research each fund to figure out how it’s performed relative to peers. Also consider fund manager track records and look at whether funds have stayed true to their investing goals.
Decide how much you’ll need to save now and by how much you’ll need to increase your savings over time. Consider how your investments might perform using historical numbers tied to your asset class allocation and future economic forecasts.
Establish a plan that includes calendar reminders. The plan should contain the dates when you’ll:
- Increase your contribution. It’s good to do this every year or two.
- Re-balance your portfolio to ensure you maintain your desired asset class allocation. Do this quarterly or twice yearly.
- Reassess your asset class allocation. You should do this every couple of years, or more often if you’re within 10 years of retirement or if economic conditions are changing rapidly. Continue to reassess throughout retirement.
If this seems like a hassle, consider working with a professional. Don’t just bury your head in the sand; your retirement nest egg is too important. There are better options than looking over the shoulder of your office-mate.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal. Keep tabs on Scott on Twitter and Facebook.