5 Mistakes That Will Crush Your Retirement Dream
The goal of most Americans is to retire at some point in the future so that they may enjoy their "Golden Years" by spoiling grandchildren, traveling and finding the time to do all the things that they postponed during their working years. Unfortunately for most Americans the dream of a grand retirement will remain just that - a dream. Why? Because they made many mistakes along the way that sabotaged their retirement plans.
It isn't too late to start doing the things that will put you a long way towards living in your retirement dream. However, as with anything, it will require sacrifice, discipline and dedication to the plan to make it work. There are no shortcuts, no "get rich quick" scenarios or investment schemes that will bail you out in the short term or make up for the lack savings. Nope, this is all up to you, as it has always been, and the longer you delay putting a plan into action the tougher your chances of actually being able to achieve that dream will be.
Financial mistakes such as overspending, under saving, and helping children too much are all reasons why parents run deep into the red. Here are the five mistakes you must avoid for a better chance at achieving your retirement dream.
1) Not Funding Or Correctly Managing Your 401k Plan
Only about 20% of Americans actually participate in the 401k plans provided by their company. This is a major mistake for several reasons. First, many companies give you “free money” in the form of a match when you contribute to your company plan. Second, the contributions that you make today lower your taxable income and the growth of those assets are tax deferred until you retire and start drawing out the money.
In 2012 an individual under the age of 50 can contribute up to $17,000 of their paycheck to their 401k plan. (Over the age of 50 anytime in 2012 your limit rises to $22,500) Assuming that they get a 100% match on the first 3% to 6%, that is an extra $500 to $1,000 a year in savings. In other words, if you leave all of your contributed dollars in a money market fund in your company 401k plan, the match alone will provide a 3-6% annual return on your investment. That return is much better than the negative real return of the stock market over the last 12 years.
How much should you be saving in your 401k plan? Your goal should be the maximum. The problem for most Americans is that they live well beyond their means at home. This is because they spend first and try to save second. To be a successful saver, you must save first. You work hard for your money, so make it work hard for you. When you contribute to your 401k plan, the money comes out of the paycheck before you get it. This will help you adjust your budget at home so that you can live within the confines of your net salary.
When it comes to selecting the funds in your 401k plan - be EXTRA conservative. Why? Because the more risk you take, the more you stand to lose WHEN, not IF, the market declines. Remember, if you are only in cash, the match you receive from the company will generate a 3-6% annual return all by itself and that will COMPOUND on a year over year basis. The magic of compounding ONLY works if you don't lose large sums of principal. Therefore, a mix that is more conservative will, regardless of your age, ensure that the compounding effect in your 401k plan accrues overtime. If you want to speculate in the markets, do that in a taxable investment account, where you can write the losses off when you file your taxes.
2) Using Unrealistic Expectations In Your Financial Plan
Most retirees use unrealistic assumptions when planning for their retirement. They meet with a financial planner or use some online tool that plugs in a number for estimated returns on your portfolio. This is the same mistake that pension funds have made all across this country by assuming a stagnant rate of return each year. The reality is that the financial markets DO NOT grow at 6% or 8% every year. The last two major bear market cycles will tell you that. But here’s the math to show you what I mean.
Let's assume that you start with $100,000 and assume an 8% growth rate. At the end of 5 years your initial investment will be worth $146,932. Sounds great right? Keep that up for 20 years and your initial investment will be worth a cool $466,095.
However, watch what happens if you have one down year of 8% in your 3rd year. Your initial investment will now only be worth $125,165 at the end of your 5th year and $397,044 in the 20th. That one 8% decline created a near 15% shortfall of your estimated goal. Just two 8% declines over 20 years create a 27% shortfall. Considering that the markets have regular corrections in any given 20 year period (a conservative estimate), you can see why using stagnant rates of return will leave you far short of your retirement dream. Furthermore, not including inflation related adjustments will further complicate your issues.
3) Taking Too Much Risk
Risk is a function of loss. When you place a bet at a poker table, you are betting on the odds that you will win. The risk of betting heavily on a pair of twos is not in your favor. Investing is nothing more than a bet on the future price action of the market. While many commentator and advisors will quickly point to the long term returns of the stock market, this analysis is deeply flawed.
The first problem is that even though over the last 110 years the stock market has grown, the reality is that you do not have 110 years till retirement. In reality the market has historically spent very long periods (about 16 years on average) in major secular cycles. Here’s the key - the entire positive return of the markets since 1900 has been contained within three secular bull market cycles - 1920-1929, 1945-1965, and 1982-2000. If you were invested in any other period you lost money on a buy and hold basis.
The secular bear market that began in 2000 still has further to go as we continue to deal with weak global economics. Investors that have continued to aggressively invest in equities have suffered dismal returns over the last 12 years compared to people who invested in bonds and cash. Remember, when you think about taking a risk, it means that there is a potential to get hurt. Investing is not a competition or a sport. There is no trophy for winning but there are serious consequences for losing during market downturns.
Being more conservative with your investments, particularly in your retirement plan, will yield greater results in the long term. Sure, it isn't as exciting as driving the "race car" when the markets are going up, but it certainly hurts a lot less when it crashes.
4) Not Saving Enough
For the majority of Americans the greatest hindrance to their retirement plan is a lack of savings. If you aren't saving at least 40% of your income you aren't saving enough. Sounds like a lot right? It is. However, as I started out saying - there is no short cut to your retirement dream. The average American today has less than one year's salary saved up for retirement - if this is you then it’s time to get started. Retirement is closer than you realize, regardless of your age.
The first step is to analyze your spending patterns. You have to determine what is needed to keep your committed expenses at or below 60% of your monthly household gross income. With your savings being done first you can spend the remaining income down to zero each month. I know, right now you are thinking "WHOA! This guy is nuts. There is no way I can do that!" You can do it. You and your spouse just have to commit to it which may mean some self-sacrifice now so that you can indulge later.
Living on 60% of your income is not out of the realm of possibility. However you have to:
- Get rid of credit card debt
- Eliminate committed expenses for which there are acceptable low cost substitutes and;
- Learn to “pay yourself first” by saving 40% of what you earn.
The best way to do this is to have your savings automatically deducted from your paycheck before the balance reaches your bank account.
Here are your savings by priority:
- Retirement Plans: Your 401(k), 403(B), UNI-K, SEP-IRA, etc., contribution. Set this up on an automatic payroll deduction. If you don't have it coming into the house you won't be tempted to spend it.
- Long-term savings: IRA's, Roth IRA's – Set this up on automatic bank draft so these are funded automatically each month. Again, if you can't get to it you won't be tempted to spend it.
- Short-term savings: College Savings Plans, Emergency Funds, and Investment Accounts. Bank draft these amounts as well.
- Fun money: You have worked hard and you need to enjoy the life you live. So set aside some money with which you can spend on anything you like during the month, so long as the total doesn't exceed 10% of your income.
You may have noticed that only 70% of your paycheck is used for everyday expenses. Since you never see the other 30%, you generally won't miss it. The cool part of this plan is that once you’re set up on the plan you don't really need to track your expenses, because your checking account balance is generally equal to the amount of money you can spend. Most people stress at the end of the month because they are trying to figure out how to save money, but since your savings are already deposited, you can spend as you want.
5) The "Bank Of Parents"
Empowering children is the toughest thing I have to discourage people from doing. As a parent I understand the love we have for our children and the feeling of “responsibility” to do anything in the world for them. However, you have to be realistic about your situation. If you sacrifice everything for your children, you won't be able to retire. However, it gets worse. You won't live forever, and the average American will spend the bulk of his or her retirement on healthcare in the last few years of their life. Guess who gets to foot the bill when you can't care for yourself?
While you think you’re helping your kids by supporting them long after they should be out on their own, this only increases the chance that you will become a burden to them later in life. Is that really the legacy that you want to leave your children?
Sometimes saying "no" and cutting off the credit lines is the push that children need to step out and start making it on their own.
When it comes to college, it's perfectly natural to feel guilty about not being able to help more, but you’re not a "deadbeat parent" if you ask your children to help pay their way by working. You can still find some middle ground by helping pay for books, commuting expenses, or by paying some of the living expenses. Asking your child to help pay their way through school gives them a sense of ownership in their education. It also begins to instill discipline and responsibility that will benefit them after graduation, not to mention giving them some much needed work experience for their resume.
It's Up To You
You need to make your own choices as you move towards your retirement goal. If the problem is having champagne tastes on a beer budget, you'll need to take a long, hard look at where the money is going and why.
The real secret to your retirement dream isn't building a budget and tracking what you spend any more than counting calories is the secret to losing weight. The key is creating a sustainable structure for your finances that balances spending with income and leaves enough room for the unexpected.
Get out of debt. Stay out of debt. Live on Cash. Save Like Crazy
If you do that, you’ll have a high probability of being able to reach your retirement dream.