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Friday, August 30, 2013
This isn't even touching on the business ventures people have gotten into with their bother-in-laws.
These mistakes all involve what economists call explicit costs. For example, it is straightforward and easy to calculate the impact of a portfolio dropping from $180,000 to $100,000 because the dot.com market fell off the cliff or $30,000 put into a business that went belly up.
A more subtle mistake that affects more people, in my experience, involves implicit or what economists call opportunity costs. To economists, these are very real costs; and in the investment world, a big source is poor asset allocation. I know some readers are thinking this isn't a problem they may have because they think they don't have an asset allocation. Well, here's the news - everybody with assets has an asset allocation. This is akin to the oft-made observation that not making a decision is, in fact, making a decision.
When it comes to asset allocation, people will say "I haven't decided on an asset allocation so I've kept a big chunk of my money in cash." OK then. As I look at their accounts, I still see an asset allocation of, say, 60% cash, etc. What is the cost? What about the past 12 months?
As it turns out, a portfolio of 60% stocks/40% bonds + cash is up 8.21% year-to-date. $100,000 parked in cash since the beginning of the year has had an opportunity cost of more than $8,000. Consider this over a multi-year period, as happens with some people, and you see why I consider mis-allocation of assets the biggest investment mistake of many.
Admittedly, we don't know where the market is headed in the short run; and, in fact, the cost could be reduced sharply from here or it could go higher. Over the longer term, though, carefully thinking about asset allocation and potential opportunity costs is critical for retirement success for many individuals and is a potential mistake worth seeking to avoid.