Successful investing takes a lot of patience. Risk tolerance and time horizon are important factors in determining an appropriate investment strategy. For example, some investments would be unwise to choose if the principal is needed on a specific date in the next few years. You wouldn’t invest in a technology stock with funds needed to pay taxes due April 15 or with funds needed for the closing of a new home in the next few months. Sometimes, however, investors put money they need in the short term into higher risk investments more suitable for a long-term investment horizon.
The opposite also holds true. A well-educated investor shouldn’t put their portfolio in short-term oriented investments if the horizon is long-term for those funds. Additionally, some investment products offer guarantees that are not needed if one is properly diversified and understands market cycles, and these guarantees add significant cost to the underlying investment and have a meaningful drag on performance. Avoiding these common mistakes can have a dramatic impact on the long-term performance of a portfolio as well as the investor’s net worth and lifestyle in retirement.
Too often we meet new clients who have owned investments for many years that should have been allocated more appropriately. If they had been, the value could have been significantly higher, depending on market conditions, timing, fees, taxes and other factors. Let’s explore how to avoid three common investing misconceptions; what I’m calling the “ABCs of long-term investing mistakes.”
A for Annuities
The first unwise investment for the long-term is annuities, both fixed and variable. Variable index annuities are often marketed as offering equity-linked upside with certain contract features intended to limit losses. However, returns are typically subject to caps or participation 
rates and other contract terms, and results cannot be guaranteed.
Whenever a new client comes to us with a variable annuity or an index annuity in their portfolio, we analyze the cost structure of the product and the terms of the contract. In our experience reviewing certain variable annuity contracts, total internal expenses (including multiple layers of fees) can be significant. In some cases, these costs have exceeded 3% annually, depending on the specific contract and optional riders. Further, the index annuities we analyze tend to use indexes that exclude dividends. They also often cap the quarterly or annual performance of the account. In recent years, these caps would likely have led the policy owners to greatly underperform the indexes. Even if the underlying investment matched the performance of the market, the high cost of fees would lead to lower performance.
All investment programs have a fee or cost to the investor. However, the fees we see in variable annuities are excessive and are sometimes two to three times the cost of other common investment programs. In our experience, the index annuities typically give a return using indexes that exclude dividends and limit the upside of the invested funds. Because dividends have the potential to provide a significant portion of total return over time, excluding them in these types of annuities can lead to underperformance.
B for Bonds
A second poor long-term investment is bonds or fixed rate investments. It’s fine to allocate a portion of a portfolio to fixed rate investments if the individual wants to reduce the short-term risk of their portfolio and accept a lower overall long-term return. Far too often we meet investors who have too much allocated to fixed income in a portfolio with a long-term investment horizon.
A few years ago, we started working with a client who was nearing retirement and all her 401(k) was allocated to a bond fund that averaged less than 2% per year over the prior decade. We cannot correct past mistakes but can better allocate funds for the future. This investor followed our advice and gained higher returns in the following few years than had been earned in the prior decade.
Results vary by investor and market conditions. The above example is illustrative, and not representative, of all client experiences. Past performance is not indicative of future results.
C for Cash Value in Life Insurance
We often see permanent life insurance policies in client portfolios with cash balances that could have been invested in other ways. There are multiple types of life insurance, and every CERTIFIED FINANCIAL PLANNER® professional would agree that life insurance is needed at certain stages of life to protect one’s dependents against an untimely death. However, life insurance is best utilized as a temporary protection, just as you wouldn’t insure a car you no longer own. If you have saved and built your wealth over your career, you don’t need to keep paying for life insurance after your children leave the home, or you and your spouse have built enough wealth to retire or achieve financial independence.
Paying term insurance premiums costs a fraction of the cost of permanent insurance and well-disciplined savers will buy term life insurance for twenty to thirty years, the time to raise a family and save enough for retirement, and invest on a regular basis. The cost to buy permanent insurance can be five times more than term insurance and the rate of return on the cash balance that builds up in permanent policies average between 2 and 5% historically. Investing the difference in the market can earn a significantly higher amount over twenty or thirty years while the term insurance coverage is needed. This avoids the major permanent cost of life insurance.
Keeping a Balanced Portfolio
This article is not advocating for not having any low-risk investments in your portfolio. Rather, we are offering qualified information for investors to make informed decisions about investment options over their true time horizon.
CERTIFIED FINANCIAL PLANNER® professionals operate as fiduciaries, meaning our recommendations must always be in the best interest of our clients. However, many other financial industry advisors do not act under the same standard, and their recommendations may not be in their clients’ best long-term interest. Efforts have been made to require all financial advisors be subject to the same high standards as CERTIFIED FINANCIAL PLANNER® professionals, but no significant progress has yet been made by federal regulators.
