Many readers are a long ways away from retirement.
Messing up on retirement is not yet on one’s radar.
But it should be.
And the sooner you realize how people mess up retirement, the easier it is to avoid problems.
Consumer Reports outlines “7 Easy Ways to Mess Up Retirement”.
Good points. Ones that are relatively easy to avoid if you know they exist.
1. Not Having a Plan
You fail to plan, you plan to fail.
Different financial professionals recommend varying ways to plan. But all agree that you need to plan. If you meet one that says you do not need to plan, run do not walk.
I believe that creating an Investment Policy Statement is a great way to plan.
An Investment Policy Statement incorporates your unique investor profile. That is, your current financial situation, investment objectives, financial constraints, investing time horizon, phase in your life-cycle, and personal risk tolerance.
From this, you can then develop a comprehensive investment strategy that meets your needs and and unique personal situation.
2. Not Having Alternative Plans
The Investment Policy Statement cannot be a one and done document.
As life changes over time, the Investment Policy Statement must be reviewed and updated.
You win $5 million in a lottery? That completely changes your retirement planning.
You get convicted of drunk driving and lose your $100,000 a year job? That also impacts your retirement planning.
And it is not just you. Governments can change tax rates, devalue the currency, adjust access to social welfare programs, etc. Your company can introduce stock option plans, reduce the company pension scheme, go bankrupt, etc. The economy can experience inflation, high unemployment, high gas prices, etc. Investment markets can change significantly over time.
There are so many variables that can impact your life. Many which you cannot control.
You need to monitor and amend your Investment Policy Statement as required. An annual review at minimum. Also, anytime there is a material change in your life.
If a change in strategy is warranted, then make those changes.
3. Not Knowing What You’ve Got
You should prepare a comprehensive balance sheet as part of evaluating your investor profile in the Investment Policy Statement.
Make sure it is comprehensive.
Many people forget things.
A typical omission is a home you own. Investors do not forget that they own the house, but they do often forget to include it when calculating their current asset allocation. Make sure you include yours as part of your real estate allocation.
4. Underfunding Accounts
I do not think that you can save enough each year.
Studies consistently show that individuals do not save enough for retirement.
I strongly believe that most national governments will substantially reduce benefits in their social welfare programs. This may be due to clawbacks, higher thresholds, increased entitlement ages, etc. High government debt levels may also result in higher tax rates attaching to withdrawals from private pensions.
I also think there may be problems for individuals who are part of defined benefit corporate pension plans. Many of these are not fully funded.
Of the 341 companies in the S&P 500 index with defined benefit pension plans, 97 percent are underfunded, according to a Credit Suisse analysis. Despite generous contributions last year, Credit Suisse estimated the plans’ liabilities at $458 billion at the end of 2011, an 86 percent increase from a year earlier.
Others rely on very optimistic returns to justify their funding levels.
The median expected rate of return on pension-plan assets at companies in the S&P 500 has dropped from 9.1% a decade ago to a still-high 7.8%
Among major public-employee pension plans, the median assumed return is 8%
Is that realistic given recent rates of return on cash, fixed income, and equities?
Consider a corporate plan projecting a long-term average annual rate of return of 8% and holding 50% stocks and 50% bonds.
With the Barclays Capital U.S. Aggregate bond index yielding around 2.2%, a 50% allocation to bonds contributes 1.1% annually to the portfolio’s overall return. Stocks have to make up the remaining 6.9% for the entire portfolio to hit the 8% target.
If stocks gain 10% annually, a 50% allocation to them will provide 5% of return, not the 6.9% needed. For this hypothetical portfolio to return 8%, stocks need to gain an average of 13.8%. That would be nice—and unlikely. Over the past 10 and 20 years, respectively, the Dow Jones U.S. Total Stock Market Index has returned 3.9% and 8% annually.
The probability of meeting these assumed rates of return is low. That means more funding problems for these pensions. And potentially payment issues for fund participants.
Try to maximize contributions to personal pension plans, then save through non-registered investment accounts. It is not wise to rely solely on your government and company pensions.
The sooner you begin to contribute, the less money you will have to invest over time.
5. Wimping Out On Risk
Many investors, especially young investors, are too cautious in their risk levels.
I am not telling you to take your savings, run to Las Vegas, and put it all on black 26 at the roulette table.
But investors should understand the relationship between risk and expected return. Then take an less emotional approach to investing.
I do not think individuals need to become investment experts. But it is helpful to spend a little time learning about the investment process. It will definitely help in your planning and investing for retirement.
This could also be a good time to work with a competent financial planner. Someone that can assist you in making more rational investment decisions. Yes, it will cost a little today. But the returns may be well worth the price.
6. Ignoring Fees
Expand this to cover all investment costs – transaction costs, mutual fund sales charges, portfolio management fees, administrative and operating expenses, and income taxes.
I would also factor in financial planner support. Either commission based or fee only planners.
Lower costs equals stronger performance.
However, do not sacrifice service and portfolio performance just to find the cheapest options.
7. Depending on Home Equity
Traditionally, the family home was a key source of retirement capital.
At some point, the home owners would sell their house, “trade down” to lower cost accommodation, and live in part off the cash proceeds.
That system worked well for many years. But as we have seen over the last decade, it is not a guaranteed strategy.
Maybe housing prices will rebound. I think over the mid to long run that they will, on average, strengthen. Now may be a good time to buy if you are looking for long-term appreciation.
But it is not a given. There will be fluctuations over time based on general economic conditions, government legislation, etc. There will also be differences between real estate markets, as well as within specific sectors.
I stated above that we cannot be certain that government and corporate pension plans will provide the same benefits in future as they do today.
I think prudence should also apply with the future realizable value of your home. Do not plan to live off your home proceeds. If real estate bounces back, great. If not, you will be prepared.
As I like to say, hope for the best but expect the worst.
Plan for your future.
Start saving today.
Invest in low cost diversified products, such as index funds, that meet your investment goals.
Do not rely on governments, company pensions, or home, to provide for your retirement.
If you are going to err, better that it be on the side of caution.
I would much rather see clients complain to me that they saved way too much by the time they retired. Instead of seeing them struggle to live in retirement because they did not save enough.