The road to retirement is filled with obstacles and challenges. Your investments may not provide the return you had expected. Inflation could be greater than you planned and could eat away at your asset’s future value. You might invest in the wrong types of asset classes (stocks, bonds, etc.). Expenses could increase due to unexpected events (medical costs), changes in lifestyle (travel), or changes in law (taxes). Life has a way putting monkey wrenches in our plans.
Most investors know the biggest mistakes even if they find them hard to avoid, like not implementing a saving plan early, not saving enough, putting all their eggs in one basket, hoping for unrealistic returns, investing with borrowed money, chasing big yields, or squandering the retirement money early on travel and toys. But there is another level of mistakes that you need to avoid — missteps you can make by not knowing enough or not keeping your eye on the ball. Here are five of the most common missteps financial advisors see.
1. Set It and Forget It
The biggest retirement misstep of all is not investing. It is a good thing that many investors have followed financial professional’s advice and bought mutual funds, exchange-traded funds and target-date funds and then wisely refrained from trying to time the market to constantly make changes, but it is possible to take the "set it and forget it" approach too far.
Retirement accounts allow you to make your contributions or investments automatic, so you'll be able to invest and save without even thinking about it. The misstep comes when you forget to make changes, like rebalancing when one asset class becomes too big or small, or forgetting to adjust when your situation changes. As you get older, consider job changes, salary increases and lifestyle changes as an opportunity to evaluate your savings plan and how much you are contributing to your retirement.
2. Confusing Asset Price with Asset Value
A fallen asset price looks like a bargain and makes it easier to amass a lot of it in your portfolio, but it does not necessarily mean you got a good deal. You could have fallen into a value trap. This is when the asset’s price keeping going lower and lower because the underlying earnings are declining.
The more important thing to remember when investing in an asset is that it does not matter when the price came from, but where it is going. The potential increase in an asset’s value is based on its potential or future earnings or cash flow. Determining an asset’s future value takes a lot more than seeing it at a new low.
3. Managing Taxes
The same investment can be a winner in one type of account or not so good in another. You need to think carefully about what to own in a taxable account versus a tax deferred account (IRA, 401(k), 403(b)) or Roth accounts.
In a taxable account, interest and dividends are taxed the year they are received, and profits on investments that are sold are taxed the year of the transaction. Different rates apply to each type of income or gain. In a tax deferred account taxes on interest, dividends and sales profits are postponed until money is withdrawn, and then all are taxed as income. Roth accounts are treated even differently.
This means the same investment can be taxed more in one type of account than in another. Similar considerations surround dividend earnings, especially for the retiree who plans to spend them rather than reinvest. For most investors, dividends are taxed at 15% in taxable accounts, but at rates as high as 37% in tax deferred accounts based on a person’s tax bracket.
No one knows how the tax laws may change, so most planners assume current rules will continue. As a rule, it is better to pay tax in years your tax bracket is lower and defer income when your tax bracket is higher. Understanding your current and future tax bracket can help you save money on taxes and open up more planning opportunities in the future.
4. Paying High Fees
Individual investors think that they can only get good returns by putting their retirement accounts with professional money. However, they ignore the impact of the 1% to 3% fee that can be charged for managing their assets. Always make sure you understand the impact of fees on your net rate of return (rate of return minus fees) to make sure your assets are producing the right level of income or potential gain.
There are many investment products on the market that allow individual investors to mirror the rates of return on certain assets classes with very low fees, many with less than 0.5% fees.
5. Underestimating Future Expenses
How much will you spend on food, shelter and clothing after you retire? Not only do many people fail to add these up, many have no clear budget for travel, entertainment and health care, experts say. Assuming you will just live on whatever you have or that retirement will be a permanent spending spree could lead to bad decisions when investing, like being either too risky or too conservative.
Generally, investment experts say that you should expect to need between 65% to 85% percent of your pre-retirement income each year during retirement. However, individual cases can vary widely, especially around health-care costs as you age. It's best to plan this out several years before you retire to make sure you're covering all the bases.
6. Treating Retirement Models and Calculators as Gospel
The old saying goes - Battle plans survive until there is first contact with the enemy, and then everything changes. Today many advisors use retirement models and calculators that can run thousands of scenarios with different combinations of returns for various assets to produce a probability that your retirement money will last.
But although the computer runs use a range of investment returns, they are typically based on past patterns, and that do not account for investor behavior. Individual investors do not earn market returns. Numerous studies show that individual investors do not stay in the market at all times. They tend to liquidate during a down market, and miss the rebound by staying out too long. This results in individual investors earning 1% to 4% less than the market averages each year, reducing their expected rate of return.
Bottom line: Address these missteps early and often. Make a plan and stick to it but allow for flexibility to deal with the unexpected. Find a Financial Coach to help you create and implement a plan.
If you are looking for a Financial Coach that can work with you to develop a strong strategy for next year - contact Stephen Westurn (214.240.0701) or Stephen@Westurnconsulting.com for a get acquainted session.
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