More portfolio pitfalls to avoid

Posted by on February 11, 2014 @ 12:00 pm in Personal finance

In a prior post, I covered three common portfolio errors that might derail you from achieving your financial goals. The first was arguably the most common: innocently neglecting your portfolio to later find that your holdings are no longer aligned with your investing time horizon or risk tolerance. The second and third errors were more specific, focusing on the often unintentional introduction of security concentration risk and shortfall risk to your portfolio

In this second installment, I’ll discuss three more potential investing errors. Again, this isn’t intended to be an exhaustive list, and many common investing errors can be remedied with minor adjustments.

Missing out on the match

Many employers provide some form of a “company match” in their retirement savings plan. Here’s how it works: Your employer offers to match your plan contribution with company funds at a certain rate and up to a specified percentage. For instance, your company might provide 50 cents for every dollar that you contribute to your plan, up to a maximum of 6% of your pay per year.

The company match is a rare gift in investing that you’d be crazy to pass up. Taking advantage of your employer’s match increases your retirement readiness at a faster pace than you’d accomplish on your own. And participating in the match as early as possible gives you the additional benefit of compounding over a longer time horizon.

Of course, it’s not always simple when real life intervenes. If you’re early in your career, you might be paying down debt or saving for your first home. You might be dealing with alimony, elder care, or personal health issues. For any number of valid reasons, contributing to your 401(k) plan may take a back seat to other priorities. This appears particularly true for investors under age 25, only 40% of whom participate in their company savings plan.2 If you aspire to participate in your company’s plan but aren’t quite there yet, consider starting slowly with the goal of meeting the full company match—and hopefully more—over time. The majority of plans now include an automatic increase feature that encourages you to commit to a contribution increase each year.3 For example, if you join the plan with a 1% contribution and commit to “step up” to a 2% contribution in your second year, 3% the year after, and so on, you’ll soon be taking full advantage of your employer’s generosity and boosting your retirement savings outlook while you’re at it.

But, please, don’t stop there. At the risk of being a wet blanket, I have to point out that Vanguard’s research recommends a contribution level between 12% and 15% of your income per year (inclusive of any matched employer contributions).4  Taking full advantage of an employer match is an important savings milestone, but bear in mind that you’ll probably need to contribute even more than the match percentage to increase the probability of meeting your retirement savings goals.

Forgetting that “more” isn’t always better

It’s easy to pick a handful of the “top funds” highlighted in the collection of financial magazines gathering dust in your dentist’s waiting room, but it’s not a great way to construct a broadly diversified portfolio. Assembling a random collection of funds in your portfolio can lead to unintended consequences. For instance, you may end up invested in multiple funds with overlapping market exposures. An investor might hold the Vanguard 500 Index in their 401(k) plan and later purchase the Vanguard Total Stock Market Index in an IRA, not realizing the degree of duplicate holdings between the two funds. The former provides exposure to approximately 500 large-cap growth and value stocks. The latter holds several thousand securities, covering the large-cap stock universe as well as providing exposure to small- and mid-cap companies. A quick review of each fund’s 10 largest holdings as of year-end 2013 reveals that they held the same top 10 stocks in common. In short, an investor holding both funds may unintentionally tilt their overall portfolio more toward large-cap equities than they realize or intended. While index funds provide an easy example, it’s worth noting that the same concept might apply if you hold several actively managed equity funds with a similar investment objective.

Taking home bias too far

Investing broadly in stocks, bonds, and cash, including foreign securities, is paramount to lowering the overall volatility within your portfolio. Yet studies repeatedly indicate that investors forgo the full diversification benefits of investing in international securities, instead demonstrating varying degrees of “home country bias.” A home bias occurs when an investor carries an over-allocation to domestic assets in their portfolio. Reasons for home bias might be as varied as investors themselves, but a few hypotheses exist. Investors exhibiting a home bias may have a simple preference for the familiar, or a greater level of comfort investing in their home market. Appropriate or not, investors may hold presumably higher market return expectations for their home country or perceive foreign investments as risky relative to domestic options. Whatever the cause, an opportunity exists for investors who exercise a strong home bias to reduce risk in their portfolio by adding foreign securities to the mix. If you’re looking for some rough guidance to gauge where you stand on the continuum of home country bias, Vanguard’s research supports an allocation to international equities of 20%–40% of your total stock portfolio5 and an allocation to international bonds of approximately 20% of your overall bond portfolio.6

Our running list of portfolio errors now stands at six. Chances are that one or more might sound familiar to you. If that’s the case, I’m speaking to you when I say that portfolio perfection eludes many of us. My own portfolio occasionally suffers from minor neglect. I may not rebalance quite as often as I know I should. But, I do my best to stay focused on my family’s long-term financial goals, adhere to the basic principles of investment success, and avoid the temptation to obsess too much about everything in between. It’s not portfolio perfection, but it’s served me reasonably well so far.

Has this series helped you identify any minor tweaks you might want to make to your own portfolio? Or perhaps prompted you to help a loved one pay closer attention to theirs? __________________________________________________________________

¹ In Vanguard’s How America Saves 2013: A report on Vanguard 2012 defined contribution plan data, the median and average company match amounts promised to participating employees are 3% and 3.9%, respectively. The company match example cited in the post—”fifty cents for every dollar invested up to 6% of pay”—emerged as the most common in Vanguard’s research.

2 How America Saves 2013: A report on Vanguard 2012 defined contribution plan data, p. 23.

86% of plans included in Vanguard’s How America Saves 2013 research offered participants an automatic increase feature, p. 20.

4 How America Saves 2013: A report on Vanguard 2012 defined contribution plan data, p. 36.

5 Philips, Christopher B., 2012. Considerations for investing in non-U.S. equities. Valley Forge, Pa.: The Vanguard Group.

“What’s the right allocation to international bonds?” Vanguard. https://personal.vanguard.com/us/insights/article/intl-bond-allocation-052013

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