A pothole in the road can throw off your car’s alignment. Likewise, investing potholes can permanently throw off your retirement plans.
Take unadvertised fees, for instance. Paying an additional 1 percent in fees every year over the span of a career can lighten your account by tens of thousands of dollars at retirement.
Similarly, investing too conservatively is riskier in the long run. When you’re years away from retirement – and even if you’ve already retired – it’s important to have some exposure to stocks. Since the market crash in 2008, many investors have been hesitant to take risks with their portfolio because they don’t want to lose money. While that’s understandable, consider this: In the 10 years since June of 2008, the market as measured by the benchmark S&P 500 has more than doubled.
Learn how to avoid these seven biggest investing mistakes so you can reach your retirement goals, and utilize the proper savings tips to solidify your financial future.
The Bankrate Daily
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Not taking full advantage of tax breaks
A person’s actual investments can be less important than the types of accounts used for retirement investing.
The tax-favorable 401(k) plans and individual retirement accounts, or IRAs, are a huge leg up in getting to retirement because they enable your tax-deferred earnings to compound. Fortunately, most workers with access to 401(k) plans do take advantage of them.
It’s particularly unwise to pass up the opportunity to invest in a plan when your employer matches a portion of your contributions. That’s because you’re passing up free money — the equivalent of refusing a salary increase when it’s offered.
Workers with no access to a company plan should open an IRA, yet few people make IRA contributions – only about 12 percent, according to the Investment Company Institute, an industry trade group.
Be the exception to the rule. To make it easy, set it up so that your IRA account gets automatic contributions from each paycheck.
Along with taking advantage of tax breaks, rewards cards are a surefire way to amplify your regular monthly spending.
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Not saving enough — or at all
Once you sign up for a 401(k), figuring out the best amount to contribute is the next hurdle. Your employer may have a default contribution rate of only 3 percent, so it’s best to take control and choose a higher percentage if you can afford it.
How much do most people put away? At the median, the contribution rate is 6 percent, says Alicia Munnell, director of the Center for Retirement Research at Boston College. That means half of workers contribute more, and half less. Employers typically match 50 cents on the dollar on the first 6 percent of pay, totaling a match of 3 percent of pay, Munnell says.
Is that combination enough? Munnell says it depends on when a person starts saving. “For a person starting at 25 and planning to retire at 67, a 9 percent employee-employer combined saving rate might be sufficient to maintain their pre-retirement living standard in retirement.”
But if you want to retire at 62, plan on putting away 17 percent. And if you wait until age 35, save 14 percent if you plan to retire at 67, she says.
“Given that many people shift jobs and move in and out of 401(k) coverage, a 9 percent contribution rate is probably inadequate for the vast majority of the workforce,” Munnell says.
Feeling overwhelmed and far behind your savings goals? Check out this concise guide to save money fast and get yourself on the right financial track.
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High fees in retirement plans, investments
From the expenses charged by mutual funds to record-keeping costs, fees add up. That translates to fewer dollars available for compounding and a lot less money at retirement.
Plan fees can run as high as 4 percent, but “an acceptable level is around 1.5 percent for everything,” says Craig Morningstar, chief operating officer at Dynamic Wealth Advisors. That includes the mutual fund fee known as the expense ratio.
If plan fees are unreasonably high, participants should ask if the plan is working with a professional plan fiduciary. Professional fiduciaries, whose duty is to act in the best interests of their clients, can save a plan enough money to more than make up for their expense.
Workers can most easily control mutual fund costs by making smart investment choices. Since high fees can negate any outperformance above benchmarks, low-cost index funds are generally a smart option. Many employers incorporate index options in the target-date funds they offer.
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Focusing on only one risk
Most people need to get substantial returns on their portfolio to arrive at retirement with a decent-sized pot of money. That means investing in stocks is actually a prudent move. However, some people believe they can get by without investing in stocks at all.
Avoiding stock market risk increases other types of risk, like the possibility of outliving your money.
“A CD is a low-risk investment,” Munnell says, “but (it) produces very low levels of investment income. Savings rates would have to be extraordinarily high in order to reach the target asset accumulation needed to achieve retirement security.”
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Then there are the investors who follow the herd and jump in as the market is going up, investing in hot sectors on a whim, often taking on more risk than they might otherwise.
“It’s not only being too aggressive, but not having a whole plan. When the market is going up, they take on too much risk for their investment profile. (Then) when the market pulls back their accounts, (they) see a decline and they go to cash without a plan on when to get back in,” says Christopher Zeches, CFP professional and managing partner of Zeches Wealth Management.
Similarly, there are savers who manage to sock away money, but never come up with an investing plan.
Determine the right asset allocation for your portfolio and stick with it until you get close to retirement.
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Retiring with no plan for income
As you get close to retirement, the asset allocation of your portfolio should shift to a more conservative stance. Ideally, people begin to transition their portfolio into retirement mode years before they actually retire.
Throughout their career, when they’re in the accumulation stage, workers have lots of time to save money and wisely invest in a range of assets. As retirement nears, the mix of investments needs to change, moving from capital appreciation toward capital preservation during the distribution phase. Investors should rebalance their portfolio to make sure their risk tolerance matches their age and timeline to retirement. That usually means scaling back equity exposure and increasing the amount of bonds in the portfolio. Of course, some exposure to stocks is warranted since retirement can last 30 or more years.
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Holding on to the hoarding mentality
Once you have amassed a handsome sum, it may be difficult to relinquish a portion of it to create a stream of income.
Experts often recommend getting a life annuity. Very basically, immediate annuities are insurance against outliving your money. You give the insurance company a lump sum, and they agree to give you a certain amount at regular intervals until you die.
“The problem is that people don’t like traditional single premium annuities, and they don’t buy them,” Munnell says.
The alternatives to annuities — living off of interest and dividends or using the 4 percent rule for withdrawals — can leave retirees subject to market whims or pursuing investment strategies based on their need for income instead of a prudent approach that optimally balances risk and reward.
Munnell considers advanced life deferred annuities “a more promising product.” You buy one at age 65, but wait until 80 or 85 to get a benefit.
“This product offers two advantages: 1) the buyer knows that if he lives beyond 85 he will be guaranteed a stream of income, and 2) he can spend down his accumulated assets in an orderly fashion between 65 and 85,” she says.
Since no one knows how long they will live, this strategy takes some of the guesswork out of retirement.