According to a survey by the Alliance for Lifetime Income (ALI), nearly half of American consumers between the ages of 45 and 75 feel they do not have enough retirement savings to last their lifetime. While this could be attributed to many different reasons, one of the most prevailing may be in their approach.
Retirement planning can be complicated. There are several moving parts, and if you don’t pay attention to how they all fit together, you might come up short in the end.
While there are many great strategies that can be used to retire successfully, here are six not-so-great habits that should be avoided.
1) Using Only a Savings Account
There was a time in history when putting your money in the bank was a smart move because you’d earn a decent amount of interest. However, up until last year, banks paid nearly nothing in interest to consumers. Plus, there’s no telling how long the Federal Reserve will keep the currently high interest rates in place before they start bringing them back down.
The biggest problem with saving your money in a regular old bank account is inflation. Every year, inflation decreases the purchasing power you have with your money. So unless you’re earning higher returns than the rate of inflation, your savings are basically eroding away.
This is why a better approach is to become comfortable with investing. Shoot for a goal to earn modest, realistic returns. Investing doesn’t necessarily mean gambling your life savings on companies you’ve never heard of or learning how to read green and red candlestick stock charts.
Instead, take a very plain-vanilla approach and invest in an index fund that tracks the movements of the overall market. This move alone would enable you to earn a far better return than you’re probably getting right now as well as give you a much better chance of growing your net worth to its maximum potential.
2) Investing Too Aggressively
Of course, taking the opposite approach and investing wildly in every hot stock or latest Bitcoin copycat you hear about is also a bad idea.
The internet and social media are full of self-proclaimed gurus who are very convincing at making you think that a particular company or cryptocurrency is going to quickly double or even 10X your money in a short amount of time. However, these talking hards are rarely ever right and will usually leave you disappointed.
A good rule of thumb is only to invest in something if you understand what it is and how it can be profitable. It also helps to thoroughly vet all the ways an investment could go wrong. Picking which assets to hold based on their potential downside is a part of good risk management.
3) Not Using a 401(k) or IRA
Deciding where to save your money can be just as important as how much you save, especially when it comes to your long-term plans. For most people, this will mean choosing between a taxable savings or investment account, or a tax-advantaged one such as a 401(k) or IRA.
401(k)s and IRAs are a golden gift from the IRS for several reasons. The first is that contributions are tax-deferred. This means that you’ll get to skip out on paying taxes on their income for the year. Depending on your tax bracket, that could be like getting an extra 28% bump in your contributions just based on the tax savings alone
The second is that your investments will also grow tax-deferred. With a traditional brokerage account, you’d have to report any capital gains, dividends, and interest to the IRS each year. However, with tax-advantaged retirement accounts, all of that stays sheltered until you’re ready to retire someday.
Finally, if you work at a company that offers 401(k) matching, then that’s an opportunity to get free money. Many companies will anywhere from 25 cents to a full dollar for every dollar that you contribute. That’s an easy way to double your return with virtually no effort at all.
4) Contributing Too Little
When you don’t have any idea how much you should be saving, it can be tempting to contribute just the bare minimum. Why? Because that will mean more money in your paycheck each month. However, this creates a problem for you later on down the line.
My advice is to skip the generic recommendation to save 10 percent of your paycheck and instead customize your savings rates to your needs. Depending on your lifestyle and when you’d like to be retired, you may want to save as much as 25 or even 50 percent of your income. The more you save now, the more money you’ll be able to invest and take advantage of compound growth.
5) Prioritizing Debt Over Saving
I know many people feel very strongly that they should be paying off their debt before they take any action to save for retirement. However, placing too much emphasis on reducing your debt can actually put you at a disadvantage financially.
The problem has to do with opportunity loss. It’s helpful to think of your debt as the inverse of an investment. For example, if you’ve got student loans and they have a 10% interest rate, then paying them off early is somewhat like getting a 10% return with the money you’d save in interest payments.
Depending on the type of debt you have and the rate it carries, you may actually be better off investing. For instance, suppose you got a mortgage a few years back when rates were 3 percent. In this case, it doesn’t make sense to forego saving for retirement to make early principal payments instead because you’d be missing out on a potential 10% return on your retirement portfolio. Hence, a net 7 percent opportunity loss.
Naturally, this does make sense if you have high-interest debt. For example, if your credit card carries a 25% APR, then you should definitely prioritize paying it off because that would be a massive amount of interest payments avoided.
6) Wishful Thinking
Finally, the last and least effective way to prepare for retirement is having no plan at all. Although that sounds obvious, millions of Americans do this every year. They believe things will eventually work themselves out but never take the time to formalize what their savings goals are or lay out a roadmap for how they will get there.
If you’re in this predicament, an easy place to start is to create a budget. Budgeting your money creates the groundwork for your plan and lets you know exactly how much you can allocate to your goals.
If you’re having trouble understanding how much money you spend regularly, try keeping track of your expenses for the next couple of months. You can do this automatically using a helpful app like Buxfer.
Once you have numbers to back up how much money is flowing in and out, you’ll be able to better customize your savings goals. Combine that with some of the other tips from above like using a tax-advantaged retirement plan and investing for modest growth, and you’ll be well on your way to making real financial progress.
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