Some of the reasons for not investing for a retirement return are weaker than you might think. It might be because you think finance is too complicated or you don’t understand it. But this is actually a reason to start investing.
Some of the most common mistakes of investors arise from their overconfidence. A lack of faith in your ability might perhaps save you.
Two University of California researchers, Brad Barber and Terrance Odean, have shown that overconfident investors trade too much. As a result they can lose money by paying too much in dealing fees.
Knowing “too much”?
Two other academics, Sebastian Muller and Martin Weber, have found that informed investors make bad choices of investment funds because they think they know how to spot good managers.
They’re wrong. So a lack of confidence can be a good thing. In fact, it’s easy to avoid most investment mistakes – by simply investing in funds which track the market. These are cheaper than actively managed funds and so allow you to follow what US-based economist John Cochrane has said is the most important piece of financial advice: avoid unnecessary costs.
Tracker funds are also better value than others. A report by the UK’s Financial Conduct Authority found that actively managed funds “did not outperform their own benchmarks”. Experts also choose trackers: one survey of 600 finance professors by Colby Wright and colleagues found that only about one in five try to beat the market with their own investments.
Even the most novice investor can do what these experts do, and invest in tracker funds – ideally, ones that follow the world market.
Should you fear losses?
Perhaps you’re scared that share markets will fall and you’ll lose money. However, research shows that people exaggerate this fear.
Kuehne Logistics University’s Christoph Merkle surveyed some UK investors before and after the 2008 financial crash. Merkle says that, before the crash people said that a big loss would hurt them a lot. But having suffered such losses, they were more comfortable than they expected to be. Their fear of a loss was therefore, in my view, overstated.
What’s more, there’s a simple and cheap way to mitigate this problem. You should invest regularly – say, each month via a direct debit. This means that more shares can be bought for you automatically, when the prices are lower, and fewer when they are expensive. A researcher for the Birthstar behavioural finance project, Shweta Agarwal, says this can reduce the negative feelings suffered when the market falls.
It also has other advantages, she says. If you follow a rule, you’re less likely to feel regret than if you take ad hoc decisions – especially if that rule is followed by many others, as this one is. Better still, this gets you into the good habit of regular saving.
The sooner you start…
Also, remember that there is a big cost to not saving or investing for retirement. One of the greatest friends an investor has is the power of compounding. Let’s say share markets give a return of three percent per year. In that case, £100 invested today would grow to £209 over 25 years.
That £100 would grow to only £181 over 20 years. Delaying investing by five years means missing out on a 28% return. The later you start saving, the more you’ll have to. Yes, it’s painful to deal with the paperwork of starting a pension, and tricky to save. But it’ll hurt more later.
It’s much easier to take a decision now. As Diane Garnick of pension fund TIIA says: "Waiting until retirement to think through spending strategies is akin to planning for parenthood while you're in labour."