To err is human. To retire in comfort is divine. If you’re saving and investing for your retirement, congratulations. You’re off to a great start. But are you making the right moves?
This week, we’re reviewing some common mistakes that can befall even the savviest investors as they craft their retirement savings strategy.
If you see something familiar here, trust us, you’re not alone. For nearly 25 years, we’ve partnered with clients to create risk-aware, long-term investment plans that work for them. And we’ve encountered each of items we’ll discuss below (and plenty more).
Here’s one: Sensational headlines and political vitriol can overwhelm even the steeliest investment nerves. But pulling out of stocks in favor or bonds or cash to “protect” your account is just one of the mistakes that investors will make when market volatility is high or fear trumps facts on Wall Street.
As we always say, it’s time in the markets, not market timing that will lead to successful long-term results.
So let’s assume you’re invested for the long haul. While everyone’s situation is different and no two investors have the same goals, there are a few common mistakes we come across. Tune out the noise and check out five retirement savings blunders it pays to avoid.
1. Taking a “Hands-Free” Approach
BLUNDER: Ideally, your company’s 401(k) or 403(b) retirement plan offers you a wide range of well-managed, low-cost funds. And there are ample options for building a diversified portfolio. But in reality, many such plans do not offer much choice, let alone funds that won’t take huge bites in fees.
By doing nothing and letting your hard-earned investments languish in an account with limited and overpriced options, you’re unable to fully maximize your retirement savings or implement the most effective strategy for your needs.
SOLUTION: When our clients’ company retirement plans stick them with a dearth of investment options or high fees, we’ll review whether moving their assets to a rollover IRA when they retire is an appropriate choice for them. They get the same tax-free savings and investment power, oftentimes with lower costs and much greater choice.
2. Cashing Out
BLUNDER: You cash out of your 401(k) or (403)b when you retire. Or you opt for a lump sum when you switch jobs. However, taking a lump-sum distribution can be really costly. When you make withdrawals from your retirement plan, you are responsible for paying income tax on the entire value. All withdrawals from a traditional (non-Roth) 401(k) or 403(b) are taxable. And since you made your contributions pretax, the government is going to come after its share of both your savings and the gains you’ve made over time.
If you’re under 59½ years old? Then withdrawals cost you even more. You will be taxed not just on the distributions, but are also subject to a 10% early-withdrawal penalty.
A final cash-out consideration: It’s possible that by taking a lump-sum distribution, you’ll put yourself into a higher tax bracket, making the transaction even costlier.
SOLUTION: You need to be well prepared when contemplating cashing out. First, consider whether it makes more sense to pay taxes on your account now in your current tax bracket. Or, is it preferable to roll your account over into an IRA and pay taxes later in retirement, when you may fall into a lower bracket?
(If you know that you’ll be in the same or a higher tax bracket in retirement, a Roth IRA is worth considering.)
Second, if you do decide to cash out or take that lump sum (or to rollover to a Roth IRA), you’ll need cash on hand for that year’s tax bill. The amount could be quite large, depending on how much you’ve saved up over the years.
3. Relying too Much on Company Stock
BLUNDER: You’ve heard it before: “Don’t put all of your eggs in one basket.” The same goes for investing too heavily in your company’s stock as your retirement plan. If the unthinkable happens and your company hits hard times or goes out of business, you could face the unwelcome double-whammy of losing both your job and everything you’ve worked so hard to save for retirement in one fell swoop.
SOLUTION: This is not to say that one shouldn’t invest in their company’s in a retirement portfolio. But we advise our clients to keep that portion of their invested assets small enough so that if disaster strikes, their future financial well-being remains secure.
4. Failing to Contribute Enough
BLUNDER: It can be difficult depriving yourself of hard-earned cash in the short-term by contributing the maximum to your 401(k) or 403(b). How much harder will it be to have to look for another job to make ends meet after your so-called “retirement?”
Saving as much as you possibly can while you’re still drawing a paycheck is your best defense against running out of funds after you’ve stopped working. And thanks to compounding, the more you have invested, the greater your potential earnings. This is why we recommend that clients contribute as much as they can to their retirement savings plans.
(Be sure to check whether your company has a matching funds policy, where they’ll match your contribution up to a certain point. If so, by not investing in the company plan, you’re essentially passing up free money.)
Compounding is a powerful investing tool. The more money you have working for you in your retirement account—compounding gains upon gains, year in and year out—the plumper your retirement goose will grow.
The chart below demonstrates the potent investment fuel compounding brings to your savings. In this example, $10,000 is put into a hypothetical investment in the stock market and grows 10% annually over 30 years (roughly the annual return of the S&P 500 over the last three decades). Interest represents the earnings gained on that initial principal invested, a moderate gain. But the majority of the nearly $175,000 after 30 years comes from the ever-increasing earnings made off of previous gains. That’s the power of compounding.
Source: Adviser Investments. Note: 10% rate of return is hypothetical for illustrative purposes. It is not based on historical data or actual investment returns.
5. Investing Too Conservatively
BLUNDER: Stuffing money in your mattress may feel like the safest way to save. Okay, not literally. But this is one of the most common mistakes we see people making when saving for retirement or managing their IRA rollover. The logic, such that it is, goes that because the money they’re putting away is so critical to their future financial security, it should only be invested in risk-free or ultra-safe funds. This painful misconception piles up as the adverse effects of inflation can and will erode the purchasing power of your retirement assets over time.
SOLUTION: To succeed over the long term, we advise our clients to invest a sizable portion of their assets in stocks. There’s no need to take wild risks. Everyone’s risk comfort zone is different. But the goal should be to grow a retirement portfolio over time and maintain the “real” value of assets after accounting for inflation.
We understand that this advice could have a short-term, negative impact on retirement savings in a down market. But ultimately, a long-term focus will overshadow shorter-term volatility. Historically, stocks have significantly outperformed bonds and cash, a trend we expect to see continue over meaningful, multi-year or decades-long investment timelines.
About Adviser Investments
Adviser Investments operates as an independent, professional wealth management firm with expertise in Fidelity and Vanguard funds, actively managed mutual funds, ETFs, fixed-income investing, tactical strategies and financial planning. Our investment professionals focus on helping individual investors, trusts, foundations and institutions meet their investment goals. Our minimum account size is $350,000. For the fifth consecutive year, Adviser Investments was named to Barron’s list of the top 100 independent financial advisers nationwide and its list of the top advisory firms in Massachusetts in 2017. We have also been recognized on the Financial Times 300 Top Registered Investment Advisers list in 2014, 2015 and 2016.
For more information, please visit www2.adviserinvestments.com or call 800-492-6868.
Disclaimer: This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations, personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.
Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.
Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
The Barron’s rankings consider factors such as assets under management, revenue produced for the firm, regulatory record, quality of practice and philanthropic work. This award does not consider client experience and is not indicative of future performance.
Editors at the Financial Times bestowed “elite” status on 300 firms in the U.S., as determined by assets under management, asset growth, longevity, compliance record, industry certifications and online accessibility.
© 2018 Adviser Investments, LLC. All Rights Reserved.