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Whether you have started retirement planning or don't know where to begin, learn what not to do when making investment, 401(k) and wealth management choices.
1. Not starting at all
"There is a great example of a person who starts at age 21 and another that begins at age 35,” says BECU Investment Services Senior Program Manager, Ric Sarro. Ric has worked with many investors over the years, and believes not starting is by far “the biggest mistake you can make.”
His example assumes a fixed 5% rate of return and a retirement age of 66.
- The 21-year-old invests $1,000 a year for 15 years. Then, at the age of 35, stops contributing and just lets the assets grow. Total amount invested: $15,000.
- Next, a 36-year-old begins contributing $1,000 a year for 30 years until retirement. Total amount invested = $30,000.
Who do you think would have more when they retire? The answer would seem obvious: the 35-year-old, who invested twice as much. However, in this scenario, the 20-year-old's nest egg, which was invested for 45 years, would grow to $93,263. The 35-year-old's, which was invested for 30 years? Just $66,439.1 “Almost nothing compares to the power of having time on your side and starting as early as possible,” says Ric.
1This is a hypothetical example and is not representative of any specific situation. Your results may vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
2. Deciding it's too late
Similar to not getting started, Ric cautions potential investors not to get discouraged by his example above – his story is rather meant to encourage young investors not to delay thinking of retirement.
Ultimately, it's never too late. And, once you hit your 50s, individuals are given an opportunity to “catch up” on their 401(k) contributions. Because older age is also the time individuals tend to have the most disposable income. They are typical empty-nesters in their highest earnings years, so it's an ideal time to funnel that disposable income into retirement. Yet Ric notes it's surprising how many feel like it's simply too late and choose to take their chances with Social Security alone.
3. Relying only on Social Security
Social Security was never really designed to be the end-all for retirement funding. In fact, when Social Security came out, the average life expectancy after retirement was just a handful of years. Now people are living far past original life expectancies or are even retiring at earlier ages. In order to be able to survive – and thrive – in your retirement years, most experts say you should plan for Social Security to only be 40% of your funding; the rest should come from personal savings, 401(k)s, pension plans, or other retirement options.2
4. Depending on relatives
"The mom and dad retirement plan,” says Ric “is not an option.” Some people who have given up on saving will say, “I'll just live off a relative or my inheritance.” But here's the catch: People are living a lot longer. If mom and dad's money runs out at age 85, and that person lives until 91, there is nothing left over for you. Ric notes that many people seeking financial planning advice do want to leave a legacy, building a nest egg that allows not dipping into the principle. Doing so allows individuals to pass on a legacy to their children or even a charity. But it shouldn't be relied on as a retirement plan for those without funds.
5. Ignoring your company's 401(k) match
"You're just leaving money on the table,” says Ric. “There's no investment that can consistently give you 50-100% rate of return. None – but your company may."
Many companies offer a 401(k) match program up to a certain amount. For example, Company ABC offers a 50% match up to 6% of an employee's contribution. Employees at Company ABC who contribute at least 6% of their paycheck to their 401(k) will get a 50% match on their contributions without having to do a single thing. Simply put, it's free money.
6. Not budgeting
Ric often hears clients concerned that they can't come up with money to invest. Ric tells them to think of a fish: The fish adapts to the size of the aquarium. In other words, we all learn to swim with the money we give ourselves (within reason, of course).
Ric asked his clients to try and come up with just $50 a month. “Many of my clients would later call and say, ‘I don't miss that money.' And then they would increase the amount,” says Ric. “They'd be so excited; each month they would see the statement coming in and realize, ‘Hey, I'm doing something for my future."
The fish, ultimately, would adapt. Maybe you're just starting to contribute to your 401(k) and can't fully meet your company match. But start somewhere. Eventually, try to increase your contribution with the next raise or job change. If you get a roommate and rent falls, try to increase your contribution again – see how it feels. Adapt. Change.
7. Not exploring investment options
There are generally four different ways that most people can start investing right away. Ric emphasizes that individuals first and foremost should have an emergency fund before they invest: “If you have a car repair or some other calamity, you don't want to have to pull your money out of your investment fund. At the worst possible time. You want that investment to be able to ride out the ups and downs of the market,” says Ric. “Try to build up at least 3-6 months of living expenses. That sounds like a lot, but once you save that up, you can really focus on investing.”
- Company 401(k) – Retirement savings plan offered by an employer. Contributions are pre-tax, and the money grows tax-free until the employee begins taking distributions (typically upon retirement).
- Traditional IRA – Fully deductible if you don't have access to a 401(k). If you do have a 401(k), it's only fully deductible to a certain point, then the deductibility is phased out. Taxes are deferred until you start taking distributions.
- Roth IRA – No deduction. However, when you do take distributions, they are tax-free. And, unlike traditional IRAs, you aren't required to withdraw funds at a certain age for the original owner Individuals can leave Roth IRA accounts to grow, while taking distributions from their traditional IRA.
- Annuities/Insurance – Backed by an insurance company, annuities are often overlooked. Annuities come in two main varieties: Fixed (with a fixed interest rate), or variable, where you can invest in the markets. In both cases, they provide tax deferral – you don't pay taxes until you withdraw funds.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax. The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change. Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value. This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. For information about specific insurance needs or situations, contact your insurance agent. This article is intended to assist in educating you about insurance generally and not to provide personal service. They may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you.
8. Investing emotionally
If you are losing sleep at night over your investments, you may be invested too aggressively. Even if you are properly invested in a diversified portfolio, it's common to react emotionally and want to pull money out when the markets are volatile. Yet, when you look at 10-year periods in the stock market, 90% of the time, the market is winning.3 Those are good odds. However, it comes with a big caveat: The market requires you to be invested for the long-term, and invested appropriately for your goals, time frame, and your tolerance for risk.
So, what should you invest in? A comprehensive portfolio is well diversified. Diversification can potentially smooth out the up-and-down swings that cause the sleepless nights.** “You want to hit singles and doubles with your portfolio, not home-runs,” says Ric. “That way, you have a lot less strike-outs.”
9. Not considering health costs
Drawing up a budget for later in life? Take your health-care allotment and increase it. Then increase it some more: During retirement years, it's common for individuals to have higher medical bills, spending more in retirement than many of us estimate in our younger, healthier years.
Overall, people tend to be under-insured. It is important to review your insurance policies, and reflect on your lifestyle choices: Are you adequately covered? The same coverage you purchased in your 30s is often not going to cut it for your 50s or your 70s. Consider long-term care insurance. The U.S. Department of Health and Human Services projects that 70% of all individuals turning 65 will need some form of long-term care during their lifetime.4 Long-term care is expensive and can derail your retirement plans.
Also, ask your parents if they have any long-term care coverage. Without it, you may end up taking care of a parent in your home, placing a strain on your finances and investments. Often one of the spouses has to stop working to provide in-home care. And -- much much like caring for a child – parents require food, medical care and a new room, perhaps even a customized mother-in-law suite. Remember, the less money you pay in overall care costs, the more money you can invest or keep in your retirement fund.
10. Sticking to the same plan
At age 20, you may want to travel the world when you retire. By age 40, you might plan on writing a novel. At age 60, you dream of having a ranch where your grandkids can play. It's important to have a plan; a living, breathing document. It's also important to be okay with changing the plan.
After all, life is not what it used to be. People used to have very short retirements, due to lower life expectancies. But now, individuals live and often work much longer. In fact, people are creating new careers: opening wineries, going to culinary school, starting new businesses. “They're bringing in revenue,” enthuses Ric. “Maybe they don't need anything other than that job and social security. Perhaps they're not even touching their retirement savings until much later in life. They may be in much better shape than they thought, or may want to set aside additional money for that new endeavor.”
A professional can work with you, check in with you on your goals and how your future is shaping up. Your working document is one that can change as your ideas and dreams change.
11. Putting too much pressure on yourself
Ric likes to walk his clients through an example to help them see a bigger picture. First, he gives them a destination that's 45 minutes away, and an arrival time of 5 pm. Most clients estimate needing a couple hours of drive time.
Ric: “It only takes 45 minutes. Why don't you just leave at 4:15?”
BECU member: “Well, the traffic could be bad.”
Ric: “Traffic ebbs and flows. Just speed up.”
BECU member: “But I could get a ticket. I could get in an accident.”
Ric: “So you're telling me your goal is not to get there the fastest, but to get there on time and get there safely.”
BECU member: “Ah … I see what you did there.”
It's natural to get caught up in the market, thinking it's better to go as fast as possible. However, all that's needed is to determine how much you need, and when you need to get there. The most important goal is not to get there the fastest: We're not racing anybody. The most important part is just to get there safely and on time. Don't take too much risk and don't be too hesitant. Just take the appropriate pace and you should get there.
“Consider a financial professional being like your car's GPS app,” says Ric. “GPS apps help you map where you're going, tell you how long it will take to get there, plan the best route and suggest alternate routes as traffic delays occur. It is very important to have a map to your financial goals, and ultimately someone to help you stay on course.”
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**There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Stock investing involves risk including loss of principal.
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