The risk of capital loss is a concept that is, without a doubt, well-known and feared by virtually every investor. It continues to dominate investment decisions and investors seem to be blissfully unaware of other, equally important, risks involved in making decisions surrounding their retirement.
Another equally important risk is the danger of not saving enough for retirement. The outcome is that, today, the majority of retirees unfortunately need to deal with this harsh reality on a daily basis when their monthly income just doesn’t meet their lifestyle requirements.
So why does the notion of losing capital play such a prominent role in the decision-making process of investors, often to the detriment of not meeting their income needs at retirement?
The concept of behavioural finance is useful in trying to explain why this occurrence tends to happen. The powerful force of human emotions often causes investors to go against good investment practice. In times of market uncertainty investors often act irrationally and lose sight of their long term financial goals. They allow the most recent historic events to dictate their behaviour, leading to a short-term investment focus that is sure to destroy value. Consequently investors tend to experience the risk of capital loss as an immediate threat to their savings and a scenario that could realistically occur today. In trying to minimize this threat, they often end up being too conservative when making investment decisions.
On the contrary, the realization of retiring with inadequate savings will only be evident at retirement. It is not seen as an immediate threat and takes the focus off meeting their retirement needs.
It is obvious that human emotions can have a detrimental impact on investors’ retirement goals and should therefore not be underestimated. Financial intermediaries have a critical role to play in protecting the client against their own investment imperfections and retaining the client’s focus on their long term retirement goals.
Let’s consider some of the imperfections investors need to be protected against and the detrimental impacts thereof:
The first mistake investors make
The first mistake investors tend to make is to postpone saving for retirement.
It is often argued that they are too young to be thinking about retirement. The need for a car or other consumables is high on the priority list of purchases when their first few paychecks or bonuses arrive. Unknowingly they cut down on their investment time horizon and drastically reduce the probability of meeting their retirement goals. The effect of compound interest over time is often referred to as the 8th wonder of the world and is one of the best investment tools that should not be overlooked. Investors should be encouraged to start saving as early as possible, because the longer their investment time horizon the better the effect of compound interest and the probability of meeting their income needs at retirement.
Article continues on page two and three: three more mistakes investors make time and again...