5 Pension Mistakes to Avoid

Christine Benz: Emma, great to be here.

Wall: So the U.S. retirement savings system puts a lot of onus on the individual to care about that long term retirement planning. And it's a system that the U.K. is moving towards. So I thought today we could talk about five mistakes that perhaps U.S. investors have made that U.K. investors can learn from.

Benz: Absolutely. We've observed a lot of these mistakes firsthand as we have watched investors experimenting with what are called 401(k) plans here in the U.S. We've been able to see some of the errors that they have made in managing their own investments for retirement.

Wall: And what's the first lesson?

Benz: The first lesson is investing too conservatively for your time horizon. So, I think investors often hear, ‘pay attention to your risk tolerance when allocating your assets’. So, I think oftentimes, they think about short-term risk volatility and they get very bothered by short-term volatility. And so, I think the key message is to bear in mind that if you do have a long time horizon, you're going to have to put up with some of that short-term volatility. But in the end, typically investments that are more volatile over the short-term will produce better returns over the long term.

Wall: Bit of brave investing then.

Benz: Absolutely. But it also means for people who are in say, in their 20s and 30s, means that they want to have a portfolio that's predominantly invested in stocks, ideally some sort of a globally diversified stock portfolio. And then only as they get closer to their retirement age, they want to tip more of the portfolio into safer securities.

Wall: Fantastic. And what's the second lesson?

Benz: The second lesion is kind of the flip side. One thing we often see is that, investors tend to want to drive with the rearview mirror. So they look at whatever has performed best in the recent past and they decide that's where they want to put all their money. Oftentimes unfortunately that is the category that is either the most highly valued. So the security prices have already enjoyed a strong run-up or perhaps it just has a lot of risk baked into the asset class.

So shopping based on past returns is often not a good idea. You really do need to think about the fundamentals of the investment, think about its risk reward characteristics, think about, if you're investing in some sort of a fund, product, think about the types of investments that are in that fund, and think about whether they are attractive or not attractive.

Wall: There is that investment adage which is past performance is no guarantee to future returns.

Benz: And it really isn't. In fact, we often run studies where we look at which data points tend to predict good performance or poor performance. One thing we see is that returns are very weakly correlated with future returns.

Wall: And what's your third lesson then?

Benz: Well, it's paying attention to fees or not paying attention to fees. That' a mistake that we see investors oftentimes making when managing their portfolios. And those fees, even though they seem small and innocuous, because there are expressed usually in just percentage terms, they might look like they won't be a big deal. But over time, if you're invested for a period of , say, 10 or 20 years, the difference between a low expense fund and one that charges maybe twice as much, is very substantial in terms of your take-home returns. So do comparison shop among products generally speaking you're better off sticking with the product that have the lower expenses attached to them.

Wall: But that shouldn't necessarily be the only driver of your investment.

Benz: It's not. But it's one of the few quantifiable drivers of investment results. So, you do need to pay attention to it.

Wall: And what's the fourth lesson?

Benz: The fourth lesson is taking stock of your total financial picture when deciding whether to allocate assets to your pension. So, for example, if someone has high interest credit card debt, in fact, the best return on their dollars if they have extra dollars to save or pay down – to put toward paying down debt, is probably going to be put toward paying down debt rather than investing.

Wall: Looking then instead of just at your retirement savings, at the entire personal finance picture.

Benz: Exactly. Thinking holistically about the best return on whatever dollars you have to invest.

Wall: And what's the fifth and final lesson?

Benz: The fifth and final lesson is not stepping up your contribution rate as your pay increases. One of the most painless way is to increase your savings is to make sure that as you get raises, you are actually setting additional amounts aside. That can be a great way to build your overall nice take over time.

Wall: And if you don't do that, when you come to retire, you are going to face a significant drop in the quality of your life.

Benz: That's exactly right. So, as you get close to retirement, it's really important to start taking stock of whether what you've managed to save is in fact on track to keep you may be inside the standard of living that you're enjoying while you are working.

Wall: It not quite often, it suits peoples' circumstances, because as they get older, they have less debt burden, less financial dependence, and so they really should be increasing their pension.

Benz: Exactly.

Wall: Thank you very much, Christine.

Benz: Thank you Emma.

Wall: This is Emma Wall for Morningstar.