Investing for retirement doesn’t need to be a complicated process. Given that the stock market tends to rise over time, a simple buy-and-hold strategy can deliver incredible results over the long run.
That said, to be successful in the stock market, it is crucial to get the basics right. All too often, investors make silly mistakes that cost them money and put their retirement at risk.
With that in mind, here’s a look at three common mistakes to avoid when investing for retirement.
Not owning enough stocks
One mistake that many novice investors make is that they don’t own enough stocks. For example, they may only own four or five different companies.
This is a big problem. For starters, it means that stock-specific risk is very high. If you only own four stocks and one of these tanks 50% (which can happen to even the most well-known companies – just look at BT Group or Royal Mail), your portfolio is going to take a large hit.
Secondly, with only a few stocks in your portfolio, the overall value of it is likely to fluctuate quite a lot. You could potentially underperform the overall stock market significantly.
The key, when building a retirement portfolio, is to own a wide range of stocks across different sectors so that your portfolio is diversified properly. By doing this you’ll reduce your overall risk, and give yourself a better chance of generating healthy returns over the long run.
Not investing internationally
Another common mistake that many novice investors make is that they don’t invest overseas. This is known as ‘home bias.’ It happens because, in general, people like to invest in what they’re familiar with. Worryingly, home bias seems to be quite common among UK investors. For example, a study by investment firm Charles Schwab last year found that only 7% of UK investors were looking to make significant investments in the US stock market.
Making this mistake can also impact your investment returns. Just look at the performance of the FTSE 100 index versus the performance of the US’s S&P 500 index over the last five years. Whereas the FTSE delivered a return of 6.3% per year, the S&P generated a return of 10.8% per year (figures to 31 October).
These days, it’s very easy to invest internationally through funds and ETFs and also to find FTSE 100 companies with strong international businesses. So, there’s no excuse for not adding some international investments to your portfolio for diversification purposes.
Not matching investments to your risk tolerance
Finally, another mistake that can put your retirement at risk is investing in the wrong kinds of stocks. Given that your capital is at risk when you invest in the stock market, it’s crucial to ensure that your investments match your risk tolerance.
All too often, people buy stocks that aren’t suitable for their requirements. For example, you hear about people who have invested a large amount of money in speculative small-cap stocks such as Sirius Minerals in the lead up to retirement in the hope of quadrupling their retirement pot. This kind of strategy is a recipe for disaster.
If your goal is to build a large retirement pot through the stock market, it’s important to think about risk as well as return.
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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019