Saving for retirement has become a greater responsibility for individuals, and investing opportunities can be dizzying to someone mapping out a savings plan for the future.
The process can raise more questions than it answers, but sometimes it can be just as helpful to learn what doesn’t work to avoid costly mistakes down the road.
Here are seven mistakes to avoid while reviewing your retirement investment plans, per U.S. News:
Relying on rules for retirement asset allocation.
Avoid simplistic asset allocation recommendations. Victor Haghani, the founder of Elm Partners, cautions against this retirement maxim: “Appropriate percentage allocation to equities should be 100 minus your age, or in light of longer expected lifespans, 110 or 120 minus your age,” as they ignore important variables. This rule of thumb misses an investor’s level of risk aversion, income from wealth, pension and Social Security, he says. A more holistic view must be considered, which includes income needed in retirement, bequest wishes, level of real interest rates and estimated future stock market returns. Depending upon those considerations, it might be appropriate for an 80-year-old to invest 75% in equities and 25% in fixed assets or a 40-year-old to maintain a 30% equity position.
Putting all retirement savings in IRAs and 401(k)s.
Investors enjoy the tax-deferral benefits of retirement accounts. But there’s no avoiding the tax man forever. Without additional funds, outside of a retirement account, a retiree withdrawing from a 401(k) is forced to pay taxes on that withdrawal with money from the account. “This has a downward spiraling effect on the pre-tax monies. A better accumulation strategy would be to split savings into both pretax IRA, 401(k) plans and post-tax savings like a brokerage account invested in low-fee exchange-traded funds,” says Martin E. Levine, a chief financial officer at 4Thought Financial Group. That way, investors can increase the retirement account tax-deferral benefits by withdrawing funds at a slower pace.
Focusing solely on dividends.
There’s an old investing retirement rule that advises investors to preserve principal and live on dividend income. But that rule ignores the fact that stock dividends are paid from company profits. The investor benefits whether the corporate profits are paid out in dividends or reinvested in the company to grow share value. Dividend-paying stocks are great, but don’t make the retirement mistake of concentrating all assets in one sector of dividend-paying stocks, one stock or a narrow range of only dividend stocks, says Brandon Renfro, a professor at East Texas Baptist University and a financial adviser based in Hallsville, Texas. Diversification is important as asset prices can decline, even with high dividend-paying stocks or funds.
Investing only in stocks and bonds.
Real estate investment trust, known as REITs, and other real estate investments offer another diversification benefit to current retirees and those in the accumulation phase. “The Jobs Act of 2012 changed the game for many investors, opening new doors to diversify their portfolios with more real estate options rather than sticking strictly to stocks and bonds,” said Adam Hooper, CEO and founder of RealCrowd, a crowdfunding commercial real estate firm in Oregon. Real estate investment also tends to be less volatile than the stock market acting as a stabilizer within a portfolio with a strong opportunity for returns, Hooper adds. By investing in REITs or real estate crowdfunding, investors increase their opportunity for cash flow and appreciation.
Thinking annuities are a cash flow solution.
“Annuities are often sold as a product that provides an income stream for life and can alleviate stock market volatility; however, they can be costly, fee-intensive, restrictive, without the flexibility and the level of income that retirees are going to need,” says Cory Bittner, chief operation officer at Falcon Wealth Advisors in Kansas City, Missouri. Annuities come in various forms and are an insurance product that provides income in exchange for a payment. The types of annuities include immediate, deferred and fixed and are used for various scenarios. The problem with annuities is that they are frequently expensive, difficult to understand and tough to sell. Before buying an annuity, retirees and those near retirement should educate themselves and consider low-cost annuity providers like Vanguard. Although not all annuities are bad, investing in annuities requires extreme caution and oversight.
Being too conservative with investments.
Investing in the stock market is a great way to grow wealth more rapidly than remaining in more conservative bonds and cash. But in exchange for potentially greater returns, investors must withstand periodic stock market drops. For long-term investors, those drops may serve as an opportunity to buy more equity investments on sale. Unfortunately, fearful investors, worried about future stock market declines might short-change their financial future by investing too conservatively, both in the accumulation phase and during retirement. To combat asset allocation stress, investors can choose a one-stock retirement strategy with a target-date fund. Understanding historical stock market returns can increase retirement savers’ confidence in the financial markets. Despite periodic declines, the market trends upward in most years.
Waiting too late to begin retirement saving.
With all of the conversation surrounding returns, the most important factor in wealth accumulation is time. An investor who contributes $6,300 per year from age 25 to age 65 and earns 7% annually on the investment can retire with almost a $1.4 million nest egg. In contrast, an investor who starts investing $6,300 per year at age 40 and earns an average 7% annually will only reach $428,000 in savings by age 65. The first investor’s contributions grew nearly five times. This investor contributed a total of $252,000 for 40 years to yield a $1.4 million investment portfolio. While the second investor contributed a total of $157,000 to equal $428,000 at age 65. In short, it takes less money to achieve substantial wealth if you invest early.