Everyone knows by now that saving for retirement is incredibly important. What you may not realize is that what you do with the money you save will have a huge impact on how much you need to save. If you can invest your retirement funds in such a way that you get the best possible return, you won’t need to save nearly as much in order to hit your goal. And if you don’t commit any of these retirement investing mistakes, you’re more likely to get the returns you need.
Timing the market
“Buy low, sell high” is probably the best-known investing advice out there. Unfortunately, it doesn’t come with an instruction manual. Investors who try to use this advice by buying at what they think is the bottom of the market and selling at the top inevitably make less money over the long haul than investors who simply buy quality stocks and hold on to them. And many of the people who try timing the market end up losing a lot of money, which could be devastating if you wipe out your retirement savings in the process. Choosing the right buy-and-hold stocks is easiest done by buying shares of an index fund instead of trying to pick out the right individual stocks.
Overly risky investments
When you have decades to go until your planned retirement date, you can indulge in a little risk knowing that you’ll have plenty of time to let your portfolio recover. But once you get within shouting distance of retirement, you’d better start shifting your investments away from highly volatile stocks and into calmer waters. You can figure out how much of your retirement savings should be in stocks versus bonds by subtracting your age from 110. The resulting number is the percentage of your retirement portfolio that should be in stocks. For a 50-year-old, 110 minus 50 gives a result of 60, so he should have 60% of his retirement funds in stocks and the other 40% in bonds or similarly low-risk investments.
This is a slightly more aggressive allocation than some financial experts advise. However, Americans are living longer than ever, which means they’ll have to fund a longer retirement, and they have more time to ride out the stock market’s lows. That said, make sure you gradually move money out of stocks throughout your lifetime; keeping too much money in equities late in the game means that one bad year could do irreparable damage to your portfolio.
Investments that aren’t risky enough
On the other hand, during the early years of your career, it’s important to take advantage of that long time frame ahead of you by taking some risks and thereby maxing out your potential returns. According to the “110 minus your age” formula, someone in their 20s should have 90% of their retirement savings in stocks. If you’re looking at a 30- or 40-year investment window, history suggests you can expect to earn an average of at least 7% per year on your stock investments, assuming you invest in an index fund (returns from individual stocks are more variable). That’s an extremely high return compared to other investment options, so by all means take advantage of it while you can.
Not thinking about taxes
Most people don’t exactly enjoy thinking about taxes, but they’re an important component of retirement planning. Once you retire and are no longer drawing a paycheck, you’re solely responsible for figuring out your tax requirements and sending the money to the appropriate agencies.
Taxes in retirement can have an enormous impact on how much of your income you get to keep, rather than send off to the state and federal government. For example, Social Security benefits become partly taxable if your income from other sources exceeds a certain threshold. If all your retirement savings are in traditional 401(k)s or IRAs, then all your distributions will count toward this taxable income limit, and you’ll pay more taxes on your Social Security benefits. But if some of your retirement savings are in Roth accounts, the distributions from those accounts will not qualify as taxable income, so you could take your distributions in a way that minimizes the amount of taxes you’ll owe on your Social Security benefits.
Know your limits
If you just want to enjoy your retirement without having to be an investment or tax expert, you can certainly do so. Simply choose an uncomplicated retirement planning strategy and consult with the appropriate experts as questions come up. It’s also a good idea to visit a financial planner once or twice at a minimum (once early on, and again a few years before retiring) and have them review your retirement plan and make sure it’s practical and workable.
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