How to Avoid a Retirement Disaster

The purported lesson is that if you just buy a good stock or asset, and forget about it for a few decades, you can become rich. I suspect that is what the GE employees (and all too many others) were thinking when they overweighted their retirement accounts with company stock.But here is the problem with this concept: These stories are only newsworthy when they show great wealth creation. To those who discovered dusty old shares of Enron or Lehman Brothers in 2015, no one would write the article "Local man finds worthless paper in attic. "This is a classic example of survivorship bias, and it can skew investor expectations for future returns of individual investments.

Failing to appreciate diversification: For a variety of reasons, people do not understand the value of having a broadly diversified portfolio. Perhaps they think it shows a lack of corporate loyalty to their employer; maybe it reflects a bit of a lottery-ticket mentality that perhaps your employer is the next Apple or Amazon or Alphabet (Google). Wishful thinking might suggest diversification is giving up a potential fortune. But every worker who gets company stock also gets a salary from that same employer. That is a very intense concentration of financial risk. For those workers, diversifying their company stock into broad indexes is the prudent approach. They won't become Jeff Bezos, the world's wealthiest person, but they will have happy, well-funded retirements. This is a rational and prudent trade-off (especially since almost none of us are going to become the next Jeff Bezos anyway).

Risk and reward are closely related: The flip side of all high expected returns is increased risk of lower returns. To me, this is the single most important rule of investing. To get better than average returns you must be willing to accept higher — sometimes much higher — levels of risk. This means that sometimes, you will receive lower returns and even losses. This is how investing works. The inverse is that if you want safety you must accept the inevitability of lower returns. Failing to understand these simple principles is the biggest error almost all individual investors make.

Failing to create a financial plan: All of this comes back to the basic question of why invest in the stock market in the first place. If your goal is to become rich, then (hopefully) you understand the odds, and sometimes the roll of the dice goes against you. But the more rational goal for most employees of big companies is to have more measured objectives: saving to buy a home, paying for the kids' college, and most important of all, securing a comfortable retirement. If those GE employees had created a long-term financial plan, I believe it would have been obvious to most if not all that they were taking on more risk than was necessary to achieve those goals.

The fall in GE's shares has caused many people a lot of pain. It could easily have been avoided.

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Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of "Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy."