Most of us have great friends and co-workers who we rely on for help, advice and insight.
Elle Mills recently asked her tattoo artist friend Tavian to give her a great first tattoo. He ended up giving her a tattoo of a heart with his Twitter handle?!?
Rather unfortunate. 10 minutes of fame can’t be worth that price.
In any event, just as it was a marginal decision for Elle to turn over the entire process of her first tattoo to her friend, it would be just as bad of an idea to ask Tavian how she should invest her 401(k). And not just because he probably shouldn’t be trusted.
If you are picking your 401(k) or 403(b) investment choices by asking your friends and co-workers, you’re not alone. It is a very common strategy and clients report to me all the time that they simply “asked an older person in the office”.
Here are three reasons why that isn’t a great approach:
1) Even though it may seem like many aspects of your situation are the same – you both work in the same department and for the same employer, you are both saving for retirement and you both don’t pay a ton of attention to the stock market, your situations are probably more different than you think. Understanding your unique circumstances and risk tolerance is a critical step in understanding how you should invest your 401(k) or any assets.
2) It’s hard to measure, validate and substantiate any claims that “my portfolio has done pretty awesome”. It very well may have had a great one or two year run, but that could actually have been due to luck. We also have to consider “great” compared to what. A great bond fund will look very different than a great international equity fund. And just because a fund has done great in the past, doesn’t mean it will be great in the future.
Making choices where you don’t end up with a diversified portfolio aligned to your level of risk will generally mean poorer long-term outcomes.
3) Many of us are influenced by the forces of behavioral economics:
> We like to have the comfort of knowing that we are doing what others are doing – a group mentality.
> We have the illusion of spreading risk by deciding to invest 10% in each of the 10 fund choices available.
> Being overconfident in our company stock.
> Just procrastinating and leaving all our investments in cash.
> Knowing you shouldn’t ask your friends, but picking your funds the way you pick your NCAA basketball bracket.
All of these forces, and many others, conspire against us and our attempts at making good financial decisions. You really have to have a thoughtful and disciplined plan to achieve the best long-term outcomes.