Personal Finance

The Biggest Red Flag for Retirement Savings

US Investor Sentiment, % Neutral Chart
US Investor Sentiment, % Neutral Chart

US Investor Sentiment, % Neutral data by YCharts .

Why neutrality is a danger

At first glance, neutral investor sentiment figures might seem to be less of a threat than overly bearish sentiment. After all, neutral sentiment suggests investors are willing to stay the course and see what's coming next.

Yet there are a couple problems with high levels of neutral sentiment. On one hand, they tend to reflect the uncertainties that investors have about current conditions. For instance, in the most recent survey, AAII members expressed concerns about the possibility of geopolitical disruptions, sluggish economic growth in many parts of the world, and fairly high stock market valuations. Moreover, some of their bullishness resulted from favorable U.S. monetary policy, which the Federal Reserve might start reversing within the next several months. Those concerns could lead investors to revise their retirement savings allocations, reducing their exposure to stocks in order to protect against these perceived risks.

Image: Ireneogrizek.com.

On the other hand, the AAII has found that high levels of neutral sentiment are actually one of the best indicators of future performance, at least in the short run. According to the AAII, "the best contrarian signal occurred not when investors were unusually optimistic or pessimistic but rather when they described themselves as being neutral." Stocks tend to rise sharply following high levels of neutral sentiment, with a typical gain in the S&P 500 of nearly 9% over the subsequent six months and almost 18% over the ensuing year.

This combination of nervous investors who are ready to flee and the likelihood of future positive returns poses a red flag for retirement savings. Given the difficulties in timing the market, it can be fatal to your retirement savings prospects to miss out on what proves to be the best-performing periods for stocks. Particularly for the many Americans who have saved relatively little for retirement, making the most of investment returns is crucial -- and falling into the trap of thinking you can avoid a temporary market setback runs the real risk of jeopardizing your longer-term financial prospects.

As markets climb, keeping an eye on your portfolio's risk level makes sense, with occasional rebalancing helping to ensure you aren't overly vulnerable to a market setback. But going overboard by reacting emotionally to the fear of a long-overdue market correction can do far more harm than good. Retirement savers must overcome those fears and stay on course with their long-term investing strategy.

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The article The Biggest Red Flag for Retirement Savings originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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