Five common mistakes for retirement saving and how to avoid them
If saving for retirement was easy, everyone would do it. Use these five tips to avoid some of the most common retirement saving mistakes.
Longer life spans and the disappearance of pensions make individual savings critical to retirement success. An individual retirement account — a 401(k), IRA or 403(b) — will be the biggest asset most people have when they stop working. Any major setbacks with these accounts could plague these investors throughout their retirement years.
In particular, improperly balancing your current and future spending needs and failing to follow solid investing principles can be ruinous to your retirement funds. Here are five steps you can take to avoid the most common mistakes people make with their retirement accounts.
1. Start early.
If you are lucky enough to have a pension, you know that as soon as you started working, money was taken from each paycheck to help fund your future needs. But as pensions become less common, most of us must fund our retirement accounts on our own. We decide when to start and at what level to contribute.
Early in one’s working life, there are significant spending needs, such as paying off student loan debt, saving for a down payment for a house or raising kids. Putting money aside for far-off needs such as retirement often takes a back seat to these more pressing demands.
But waiting too long to start saving is a mistake. When you’re young, time is your biggest asset, thanks to compounding interest. Start contributing to a retirement account as early as you can.
2. Save more.
It’s great that you’ve started putting part of your income toward retirement savings, but what percent of your check are you deferring? A good target is 10% of your salary. If you aren’t there yet, consider bumping up the percentage each year. Not deferring enough of your income today can haunt you later on.
If you can’t immediately increase your savings rate, do so the next time you get a raise. Move half of your additional pay to the retirement account. Doing this each time your pay increases over the next five years will help you boost your total annual deferral percentage.
3. Make sure you have the right level of risk in your portfolio.
Unfortunately, many retirement account investors don’t know how to construct a portfolio with the appropriate level of risk or how best to allocate their assets. You want a mix that gives you the least amount of risk with the highest probability of meeting your objectives.
Some 401(k) plans do offer tools for investors to better understand their retirement portfolios, but this is less true for 403(b)s and IRAs, making those investors more likely to stumble.
When choosing how to invest your retirement savings, remember that you cannot select the rate of return you want for your retirement account; you can only select the level of risk. As you get closer to retirement, the amount of risk in your portfolio should decrease.
4. Don’t look at past performance to pick investments.
How do you select what to invest in within your retirement account? Though many people know their investments should be diversified, they aren’t sure how to apply that principle. Instead, they look at past years’ returns for the funds being offered, pick a few of last year’s biggest winners and park their investments there.
But the Security and Exchange Commission and any good advisor will tell you that past performance is not a good predictor of future performance. That means the methodology that many people use to invest their retirement savings is seriously flawed.
Participants in 401(k) plans can sometimes use tools from their plan sponsors to help them make better investing decisions, but most workers simply don’t have the time, training or experience to do a good job. If you don’t know how best to invest your money and you don’t have an advisor to consult, consider using a target date fund in your plan.
5. Spend conservatively early in retirement.
You may have a reasonable amount in your account. But how much should you take out the first year of retirement? A good rule of thumb based on academic research is to take out 4% the first year of your retirement, and adjust for inflation each year thereafter. So if you have $250,000 in your retirement account, you’d plan on spending about $10,000 the year you retire.
You may want to take that great trip, remodel the bathroom or help with the grandkids’ college savings, but your retirement account will plummet abruptly. Taking out too much from your accounts early in retirement can make the next 20 or 30 years more difficult.
Planning for retirement has many pitfalls. Following these tips can help you avoid the most common and costly mistakes investors make. If you’d like further guidance, get personal help from a professional. A good choice would be advisors who work by the hour such as those in the Garrett Planning Network.
This article first appeared at NerdWallet.
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