Retirement Planning Pitfalls
Retirement planning is wide enterprise, demanding discipline and attention to detail. As such, it's bound to be fraught with pitfalls.. Most of us don't realize just how quickly time passes. Like many other large events in our lives, retirement always seems such a long way off that we often assume we have more time than we actually do to prepare for it. When we're young we can't imagine ourselves older. And when we're older we can imagine where the time went.
By following the steps outlined below, you'll be able to avoid the most common retirement planning mistakes. Bear in mind that this will take some hard work. Depending on how much your accounts are worth now, it may take quite a bit of sacrifice to save the amount of money that's needed.
Starting to Plan Too Late
One of the biggest mistakes people make is waiting until their 50s or 60s to start planning for retirement. Waiting this long typically means that more sacrifices will have to be made, sometime sacrifices that are too hard to bear. Those in their 50s and 60s often assume that since they've been putting money into a 401(k) or other employer-sponsored retirement plan will suffice. However, even with generous employer match and compounding, most people need more than just a 401(k) to comfortably retire.
If you're over 50, add the $1,000 "catch up" contribution to your retirement savings plan. If you need to, open up a new account. Take a look at how assets are allocated and talk to a financial advisor about risk and reward.
Not Saving Enough, Early Enough
The best advice is often free and surprisingly simple. This is the case with retirement planning: save early, save often, save consistently. It's easy to state but harder to implement, and that's usually the trick with great advice. It's surprising how few people actually stick to a rigorous saving schedule. Adding cash to your retirement account as early as possible during your working lifetime is the single most important factor when saving for retirement. For example, a 25-year old who funds a traditional IRA with $5,000 in 2011 (the maximum amount allowed) that earns 5% annually for 40 years will have almost $635,000 at age 65. If the account averages 10% a year, the total will be over $2,434,000.
Ignoring Free Money
Many investors fail to take full advantage of their employer's contribution matching, which is just about the same as throwing away money. Anyone fortunate enough to work for a company that offers a matching contribution to a defined contribution plan must take advantage up to the full amount. Regardless of the amount of the match the employer provides, the match is free money. For example, if the employee earns $100,000 per year and contributes 6% of total compensation, he or she is both saving $6,000 per year and reducing the tax liability for the year. If the employer matches up to 6% of the employee's salary, an additional $6,000 is added to the account. That's an immediate 100% return.
The amount of money earned and contributed each year will of course change, but for illustrative purposes, assume $6,000 is saved and matched each year for 30 years. At 5%, $12,000 per year ($360,000) becomes over $837,000 in 30 years. At 10%, that same $12,000 per month would be worth over $2,171,300.
While employer contributions can be a nice boost to your retirement savings, this strategy alone isn't sufficient to build a comfortable retirement nestegg.
Failure to Diversify
A common investment pitfall is spending far too much time trying to pick individual stocks that will increase in value. It's much more important to understand proper diversification. Diversification among stocks, such as owning growth and value stocks, stocks from different market sectors, and stocks from different countries, is critical to a retirement portfolio.
Diversification spreads risk. If one industry or sector suffers a loss (and it surely will during your working lifetime) another may gain. For example, if stocks in the consumer sectors are down, stocks in the technology sectors might be up. Further, owning bonds provides additional diversification. Stocks and bonds often move in direct opposition to each other. When stocks are down, investors buy bonds. This is called the "flight to safety."
Underestimating the Effects of Inflation
Inflation is the biggest risk to any retirement savings plan, and woe be unto any retiree who underestimates its effects. Inflation is the sustained increase in the price of goods and services over time. Most experts agree that retirees need to assume an annual inflation rate of 3-4%, but a good retirement plan should account for periods of high inflation as well.
While economists debate the causes of inflation and how to deal with it politically, one thing is certain: inflation reduces the amount of goods and services that money can buy. Inflation isn't necessarily bad if wages are rising too. If the annual rate of inflation is 3% but your salary rises 5% each year, that's ok. But if you're retired and on a fixed income, you need to make sure that your investments earn more than the rate of inflation. Otherwise, you're at risk of running out of money because goods and services will cost more than you're earning.
Two common solutions to the inflation problem are gold and real estate. Both of these assets usually rise in value as the dollar weakens. Retirees with fixed mortgages actually benefit from inflation because the value of their house grows while monthly payments remain the same.
Underestimating the Need and Cost of Healthcare
Not planning for rising healthcare costs is a huge retirement planning pitfall. There's no doubt that healthcare costs are not only rising, they arerising faster than the rate of inflation. While Medicare is available for those retirees over the age of 65, it doesn't cover everything. Any retirement plan worth its salt must account for these rising costs and offer a means of health insurance after retirement.
Current estimates project that the Medicare trust fund will become insolvent in 2017. Considering that almost 15% of the population of the United States will be age 65 or older in 2017, and 20% of the population in 25 years, it's clear that we need to save even more for healthcare in retirement.
Going it Alone
An all too common retirement planning mistake is going it alone. This usually results in missed investment opportunities, sloppy planning, and lax savings schedules. Enlisting the help of a certified financial planner is a smart move at any age to avoid retirement planning pitfalls. A certified financial planner will be able to take a look at the "big picture." He or she will be able to develop a retirement savings plan unique to your current expenses and lifestyle, and most importantly, instill the necessary discipline and rigor needed to build a solid retirement nestegg.
While we've covered the basics of retirement planning here, there is much more to securing a great retirement. To make sure you're on the right track, contact a licensed financial advisor. It only takes a few minutes, Start Now.
More Retirement Planning Guidance
- Retirement Planning Guide — The complete guide to retirement planning.
- Retirement Income Options — Explore your retirement income investing options.
- Retirement Savings Tips — Tips for how to saving for retirement.
- Building a Solid Retirement — A practial guide to implementing your retirement plan.
- Early Retirement — What it takes to plan an early retirement.
- Inflation — Understanding how inflation affects retirement planning.
- Assest Allocation & Diversification — Learn how to manage investment risk.
- Tax Considerations — How to minimize tax burden while saving for retirement.
- Retirement Planning FAQ — Frequently asked questions about retirement planning.