By Mark Stempel
Learn more about Mark on NerdWallet’s Ask an Advisor
What’s the most effective way to improve your retirement prospects? When asked this question, many people would say getting the highest return on their investments. And when asked how to do that, they might suggest picking companies that will outperform the market and then investing in those companies — or hiring money managers to pick outperforming companies.
If you could do that, your assets would indeed grow more quickly than other investors’. But that’s really hard to do. In fact, in 2014, 86% of large-cap active fund managers underperformed their benchmark, according to data from S&P Dow Jones Indices. In other words, among people whose job is to choose large-cap stocks they think will outperform, 86% of them did worse than the overall market.
Thankfully, there’s a better way to improve your odds of a successful retirement. It begins with a clear understanding of what we can and cannot control.
We have no control over what the market does. Some asset classes will go up, and some will go down. So don’t try to predict which will soar and which will tank. Instead, choose a mix of assets so you have a diversified portfolio of stocks and bonds. No matter what happens in the market, you can be confident that your portfolio will weather the storm.
Two things we can control are taxes and fees. You control taxes with asset location: putting interest-earning assets in tax-deferred and tax-free retirement accounts so that you reduce the taxes you pay on investment income. Assets that generate little or no income but instead produce capital appreciation are held in taxable accounts.
You control fees by investing in low-cost index funds and exchange-traded funds. Low expenses keep more money in your nest egg rather than putting it in the pockets of investment firms. Unfortunately, many investments are saddled with high fees that eat away at the savings you need for retirement. It’s worth your while to identify the less expensive investment offerings in your 401(k) plan by checking out the performance and fee statement that your plan must provide each year. Online 401(k) ratings can show you how the offerings in your plan stack up against other plans.
For money outside your 401(k), in traditional or Roth IRAs, or even taxable accounts, we recommend ultra-low-cost investments such as ETFs. Or, better still, work with a fee-only advisor who invests in ETFs and who can help you take advantage of asset allocation and asset location to help you make the most of your money.
Ultimately, you don’t want to rely on picking winning stocks — or picking winning stock pickers. That’s risky and really hard to do. Instead, think about what you can and can’t control, and don’t waste your energy on the things you can’t change.
This article also appears on Nasdaq.
Image via iStock.