Saving for retirement is a multi-decade investing venture, even for those approaching retirement. Indeed, actuaries in 2015 stated that there is a 70 per cent chance that one of a 65-year-old couple will reach 90 years old, meaning that even retirement is a multi-decade investing proposition.
Mistake 1
When starting a new job, employees need to choose where their regular superannuation contributions will be invested by their new employer. New employees are typically faced with a confusing list of managed funds from which to select. These new employees of all age groups typically tick a box on a form having spent less time thinking about where to invest their retirement contributions than they would spend choosing a meal off a menu.
Deciding where and how to invest their retirement savings is the biggest financial decision that individuals will make in the sense that the wrong choice will cost everyday people more in lost savings than any other financial decisions they will ever make.
It is just far too important to not put more effort into their retirement investing decision.
Mistake 2
The typical outcome of the first mistake is that 70 per cent to 75 per cent of retirement savers will default to a balanced or diversified fund of some sort.
The younger the new employee the bigger this mistake; which over the long term will cost the retirement saver multiple hundreds of thousands of dollars in forfeited retirement savings compared to electing to invest their retirement savings in a mainstream stock market index Exchange Traded Fund (ETF). Evidence shows that every superannuation fund has been out-performed by the ASX20 Accumulation index over the 24-year period starting in July 1992, when mandatory superannuation contributions were introduced.
And that outperformance excludes the additional compounding from reinvesting franking credits, which would further widen the outperformance gap. The median return of all super funds over the 24-year period is about 2.6 per cent compounded each year behind the stock market ASX20 Accumulation index, excluding franking credits.
That gap means that a retirement account of $100,000 receiving about $9,700 a year in super contributions over 24 years, indexed for inflation, would be 37 per cent, or $665,000, smaller than if the retirement saver had merely invested in the stock market accumulation index, which can be achieved through investing in an exchange-traded fund (ETF).
Indeed, the wide range of long-term annualised returns from super funds ensures that those investing in the 50 per cent of funds that achieve less than the median return will do even worse and forfeit even more than 37 per cent of their retirement nest egg.
Mistake 3
Workers allow themselves to be fee-fleeced by active fund managers such as industry and retail super funds. Industry super funds' annual fees are in the order of double to seven times higher than index ETFs. Retail Super Funds' annual fees can be in the order of five to 14 times higher than index ETFs.
For example, the annual management fee for the iShares ASX20 ETF, ILC, is 0.24 per cent a year and is 0.14 per cent a year for the Vanguard ASX300 ETF, VAS. Compare this to the average of around 0.75 per cent a year for industry super funds and around 1.85 per cent a year for retail super funds.
Paying 0.75 per cent a year more in fees every year for exactly the same long-term performance over forty years between two funds starting off at $15,000 with inflation-indexed monthly contributions would result in having $524,000 less in the retiree's nest egg. And paying 0.75 per cent a year more over 20 years starting at $200,000 will result in saving $256,000 less in a retirement nest egg.
As John Bogle, the founder of Vanguard, so aptly put it, "… the magic of compound returns is overwhelmed by the tyranny of compound costs."
Mistake 4
Mistake number four is paying financial planners and advisers ongoing annual fees as a percentage of funds under management. Adviser fees can range from 0.5 per cent a year to 2 per cent a year of the client's funds being managed by the adviser. These fees are in addition to management fees charged by the managed funds in which advisers may invest their clients' money.
Adviser fees should be normalised to the amount of effort required to service a client and their portfolio, and calculated based on hours expended. A fee that is calculated as a percentage of a client's wealth continues to scale higher in absolute terms as the client's portfolio increases.
Research by Standard and Poor's SPIVA Scorecard and SPIVA Persistence Report suggests that over the long term it is extremely unlikely that advisers or active managed funds will match let alone beat the stock market index anyway, so why pay additional adviser fees on top of higher managed fund fees to do worse over the long term.
Adviser fees and most of managed super fund fees¸ potentially costing hundreds of thousands dollars in forfeited growth over multiple decades, can be completely avoided by individuals gaining their own knowledge about index investing directly via ETFs.
Mistake 5
The last of the five biggest mistakes is being afraid of volatility and the stock market. Volatility is the friend of the long-term retirement investor and volatility should be embraced rather than run from. It is this very volatility that brings the higher returns that compounds growth over the long term.
Investors fear deep bear markets such as occurred in 2008 and hence seek safety in cash and fixed interest for long periods. However, the average time it takes for the mainstream stock market indices to recover from severe bear markets, including reinvesting dividends, is around five years. Retirement savers with more than 10 to 15 years to retirement should embrace the volatility of the stock market to achieve far better returns.
Low-effort near-passive investing in the stock market is best achieved through investing in index ETFs and reinvesting the dividends. Index ETFs track the mainstream stock market indices and hence can't go to a value of $0 as individual stocks can. Index ETFs will recover in line with the stock market – the same can't be said for individual stocks.
Gary Stone is the author of Blueprint to Wealth: Financial Freedom in 15 Minutes a Week in which he argues investing with ETFs is the best way for the everyday investor to build wealth.