If you are an investor who has made an investment mistake, you are not alone. Even the Oracle of Omaha himself, Warren Buffett, has made purchases that he somehow regrets. In an effort to generate additional income, a retirement account, send our kids to college, or perhaps finance a vacation home, almost all investors have one thing in common: they want to make more money than a salary makes.
But sometimes what drives us toward financial success can throw us off the intended path. I’ve highlighted three potential investment mistakes to avoid to keep investors on track and build stronger returns while optimizing efficiency – spending less time and money to earn more.
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1. Underestimate the benefits of a 401(k)
When people use a 401(k) to invest for retirement, they don’t pay taxes on the funds they contribute in the year they make those contributions. That’s a big advantage, but maybe not the biggest. In fact, many employers who offer 401(k)s to their employees will provide matching funds to some degree when you contribute to your account. The average matching fund cap is 3.5% of your annual salary. But some investors make the mistake of not taking full advantage of their employer contribution matching, especially if their company’s match limit is higher than average.
According to a national compensation survey from the Bureau of Labor Statistics, 56% of employers offer a 401(k) plan. Of them, 49% do not offer matching funds. Of the employers that do, 41% offer a 401(k) annual contribution of up to 6% of total wages. But 10% of all employers offer a match of 6% or more. So if you work for a company with a premium match, you must contribute at least enough to get the maximum employer match.
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So for those looking for a new job, how a potential employer handles their 401(k) plan can be an important factor to consider. As a reference, Southwest Airlines offers a match of up to 9.3%, while Duke University offers a 13.2% match for faculty and staff with salaries between $72,000 and $305,000, regardless of what the employee contributes. So if your employer matches 6% and you contribute only 1% of your salary, then it is worth increasing your contribution.
One caveat is that once you put money into a 401(k), it shouldn’t be withdrawn until you are at least 59 1/2 years old, after which it will be taxed. And if you take it out early, you’ll be charged an additional 10% penalty.
2. Putting Dividend to Work Too Late
Dividend stocks offer another way to let someone else’s money make more for you. Of course you have to invest to own stocks. But once you do, you will receive regular payments to cover your bills. Or you can reinvest those dividends to increase the number of shares you own. But some investors fail to recognize the important role dividends can play in building a portfolio over the long term.
For example, Coca Cola (NYSE: KO) is one of the elite Dividend Kings, with a record of increasing annual dividends for 60 consecutive years. At current stock prices, the current annual dividend of $1.76 yields approximately 2.7%.
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A $10,000 investment in Coca-Cola stock would get you about 154 shares right now. That’s $271 a year in passive income, or the equivalent of four additional shares if you reinvest those payouts. Run that over 30 years with an average annual dividend growth of 3.7%, plus an average price gain of 6.5% – based on the past 10 years, going back to the stock’s last split – and the result would be a total of are of approximately $19,000 in dividend income by 2052.
There are many companies that offer dividends, and many with higher yields than Coca-Cola. It’s also fair to say that the younger an investor is, the more risk he can afford to take on stocks that can have greater share price growth potential without a dividend. But this is just one example where using dividends earlier in life can help generate passive income while protecting an investor from the uncertainties associated with market volatility and an aggressive investment portfolio.
3. Being distracted by the shiny object
This can be one of the harder mistakes to overcome. Dedicated investors spend a fair amount of time and money building what they believe to be solid portfolios. They will make changes to their holdings as new recommendations emerge, or if news and earnings reports require them to adjust their investment theses.
But sometimes there can be a sudden hype around a new company, product or market, think cryptocurrency, the cannabis sector or meme stocks. These shiny objects can distract investors and dangle ahead of them the exciting possibility of becoming a millionaire overnight.
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That’s not to say that crypto or legal marijuana won’t pay off for long-term investors — these were just examples. But once the hype is over, if the bold projections don’t materialize, it’s easy to sit on a declining or worthless investment. Meanwhile, if you had sold stocks from your portfolio to fund this new investment, you might also have missed out on the profits of more reliable companies.
This is where risk/return needs to be weighed carefully. Being distracted by the shiny object can be rewarding if you catch it early, and when it takes off – two big ‘ifs’. But if you’ve built a portfolio and are approaching retirement age or sending a child to college, you need to protect that investment from the pitfalls of volatility. Now is the time not to be distracted by the shiny object.
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