Back when many American workers could count on company-run pension plans, preparing for retirement was something of a no-brainer. Now that many of us are calling the shots when it comes to saving and investing for retirement, things seem a lot more complicated.
Not surprisingly, many of us will make mistakes when it comes to preparing for retirement and managing money during retirement, particularly because greater longevity presents a challenge in terms of making savings last.
Here are a few common traps to avoid:
1. Waiting too long to start saving and/or saving too little. Some 36 percent of workers who participated in a 2014 survey by the Employee Benefit Research Institute reported that they had less than $1,000 in savings and investments.
As a rule of thumb, we’ll need about 80 percent of our pre-retirement income during retirement. The average person will get about 40 percent of his or her “replacement income” from Social Security retirement benefits, said Joseph Goldberg, director of retirement plan services for Buckingham Asset Management.
Talking about the need to save is one thing, but doing it can be hard, particularly when you are just getting started in your career and you figure that time is on your side. Of course, that’s exactly when you should begin to save, Goldberg said.
Theoretically, the sooner you start to save, the less you’ll have to save, as a percentage of your yearly salary, over the course of your career. By jump-starting your savings in your 20s, you’ll likely benefit from decades of market gains.
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2. Halting or reducing savings during bear markets. It can be unnerving to watch a sizable portfolio drop in value by more than the amount you are contributing to it each month. Many people who find themselves in that situation believe they are “throwing money out the window,” Goldberg said.
As a result, they stop saving “when what they should be doing is increasing their savings because stocks are on sale,” he added. When stock prices are low, explained Goldberg, expected returns are at their highest level.
3. Putting too much emphasis on average life expectancy. It is common for people to use average life-expectancy figures to determine how long their money will need to last in retirement. But if you happen to be lucky (or unlucky) enough to live longer than average, you risk running out of money.
Planning for a longer-than-average retirement, say five to 10 years longer than your average life expectancy, can help you mitigate the risk of outliving your assets.
“By definition, life expectancy tells you only when, out of a large group of people, half will have already died,” said David Mendels, a certified financial planner and director of planning at Creative Financial Concepts. “You have no way of knowing which group you will be in.”
4. Retiring too early. Many people are tempted to retire in their early 60s, but doing that can put considerable strain on a retirement portfolio, particularly for those who live into their 90s. By working a little longer, either at your current full-time job or at a part-time job during retirement, you can put off tapping your nest egg, giving your portfolio more time to compound, or draw down your savings more slowly.
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A part-time job during retirement, which may include consulting work or some other type of self-employment, can provide a source of funding for big-ticket items, such as travel.
Whether you retire later in life or work part-time during retirement, “anything you are not spending stays in your portfolio, not just for future use but also compounding into something more,” said J. Christopher Boyd, a CFP and chief investment officer at Asset Management Resources.
“The concept of accumulating wealth strategically is very common, but I don’t think people give much thought to the concept of distributing their wealth strategically.”
5. Failing to spend prudently during retirement. The so-called 4 percent rule is a guideline that many people, advisors included, use to determine how much an investor can safely withdraw from a broadly diversified portfolio in order to make it last three decades. The 4 percent withdrawal rate is typically adjusted for inflation in order to provide a cost-of-living increase.
But there is considerable controversy over whether this long-held belief makes sense, particularly with interest rates still at historical lows. Some experts say the rule is downright dumb because it doesn’t take into account realized—in other words, actual—market returns.
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“What you want is a rule that responds to realized market returns,” said Anthony Webb, a senior research economist at the Center for Retirement Research at Boston College. “If the market does well, you spend more and vice versa.”
Advisors say one of the biggest mistakes retirees make is not curtailing their spending during bear markets in retirement or spending too freely during bull markets. “The concept of accumulating wealth strategically is very common, but I don’t think people give much thought to the concept of distributing their wealth strategically,” said Goldberg of Buckingham.