We all make mistakes. However, some mistakes can impact us more than others. When you make mistakes with your retirement planning process, you could put your entire future at risk.
As you save for retirement, here are Five planning mistakes to avoid.
1. Overestimating Returns
Remember back when the rule of thumb was that you could expect 10% annual returns from your investments? Looking at the rule now, it seems a little excessive. When you overestimate your returns, invest too little and you feel complacent about your situation. Unfortunately, that often means that you won’t reach your retirement goals.
When you plug your information into a calculator, trying to figure out how much to save in order to reach your desired nest egg, don’t overestimate your returns. Figure a much more conservative rate of return, between 5% and 7%, for stocks. It means you have to set more money aside for retirement now, but your future self will thank you.
2. Change the Plan Due to Fear
Over time, your retirement account asset allocation should shift. You might also make tweaks depending on changing fundamentals, and shifting goals. What you don’t want to do is make changes to your plan based on fear. Many investors had a knee-jerk reaction to the financial crisis a few years ago. It led to them selling their stocks while the market was low, and then being reluctant to get back until prices had already risen.
That’s a recipe for overall losses. There are good reasons to sell investments and change your asset allocation. Sheer bloody panic isn’t one of them. Before you make changes to your retirement plan, ask yourself why you want to change things up. If you can’t come up with reasons based in fundamental analysis, consider sticking to your plan.
3. Neglecting the Impact of Inflation
Too often, we forget to plan for the impact of inflation on future finances. Inflation erodes your purchasing power, and reduces your real returns. If you see a 6% annual return on your portfolio, but inflation is at 2.5%, your real return is actually only 3.5% — and that doesn’t take into account the way fees and taxes eat into your real returns.
Don’t forget to plan for inflation as you invest for retirement. Rising prices are going to be a reality over time, and you need to include that fact in your retirement planning.
4. Failure to Account for Rising Taxes
While it would be nice if taxes stayed the same, chances are that they will rise in the future. Even if you have a lower income during retirement, you could very well have higher taxes, depending on the way things play out. As you create your retirement plan, consider the impact of taxes. In the United States, many investors choose a Roth IRA or a Roth 401(k) to help them avoid future taxes. In Canada, the TFSA is a great, flexible vehicle for saving for the future. You might pay taxes on the money now, but you avoid taxes on the earnings later.
Consider how each type of asset’s earnings are taxed, and how that might impact you later on. And plan to pay more in taxes than you expect.
5. Assuming that Your Expenses will Drop in Retirement
One of my most-hated rules of thumb is the one that tells you to assume that you will only need 75% to 80% of your current income in retirement. This assumption indicates that you will have lower expenses in retirement, but this might not be the case. Yes, you might pay off debt and have fewer of those types of obligations. However, you might also have higher expenses in other areas.
If you want to travel a lot, your expenses are likely to rise. Expensive hobbies can also boost your costs. And don’t forget health care costs. Even in Canada, there is a good chance that you will have to pay some of your health care costs as you age. In the United States, it’s practically a given that your retirement nest egg is going to have to be prepared to withstand some seriously increasing health care costs.
Don’t assume that you will be spending a lot less in retirement unless you plan to be uber-frugal.
What are some retirement planning mistakes you see others make?