Image by: Ian MacKenzie
By Michael Sterling
All investors make mistakes, some huge, others not so huge. But when it comes to investing towards retirement, the smallest errors can cost you big money down the road. Today’s culture has made it easy to think that you need to spend money to make money, yet, they rarely talk about the power of saving. Above all, there are four major mistakes bad investors make that will ultimately ruin their retirement:
#1) Being Oblivious To Tax Breaks
It’s hard to believe, but in most cases an investor’s actual investments are less important than the types of retirement accounts he uses. Unless you plan very precisely for the long term, investments are likely to be short-lived.
It never ceases to amaze me how many people fail to see the benefits that the tax-favorable 401(K) plans or individual retirement accounts (IRAs) enable them with. Both give you tax-deferred earnings to compound which gives a huge leg up towards retirement, especially when it’s sponsored by an employer.
According to Anthony Webb, a senior research economist at the Center for Retirement Research, less than one-half of the full-time private-sector workforce has access to a workplace retirement plan, but 20% of those choose not to enroll. This is a foolish move. Passing an opportunity to have a plan where your employer matches a portion of your contributions is like throwing away free money.
#2) Being Oblivious To Fees
On the flipside, investors also fail to pay attention to high fees. Until recently, people who have employer-sponsored plans didn’t have a way of knowing exactly how much their plan cost. With the expenses charged from mutual funds to record-keeping costs, fees are likely to add up. This means less money available for compounding and a smaller figure at retirement.
Plan fees can run as high as 4%, but an acceptable level is around 1.5% for everything – that includes the mutual fund fee, i.e. expense ratio. It’s important for you to have an active voice with your employer in regards to what their company offers.
*Tip: Actively-Managed Funds aren’t as good an idea as they sound. Having someone actively making investment changes on a regular basis to “seemingly” keep up with market trends might sound nice, but they charge hefty fees. Invest these fees rather than spend it on managers.
#3) Accumulating Wealth, Instead Of Generating Income
Most people who retire lose sight of what the end purpose is: to generate income, not accumulate wealth. Throughout a man’s career, he has plenty of time to squirrel away money or make smart investments in a variety of assets. But as he nears retirement the mix of his investments has to change, distancing himself from accumulation towards distribution and preservation.
This usually requires an investor to rebalance his portfolio to make sure his risk tolerance benefits his age and timeline to retirement, i.e. scaling back equity exposure and increasing the amount of bonds in the portfolio.
Too many people today focus on buying “things,” i.e. the car, the boat, the clothes, instead of saving up to invest in assets which will eventually earn them money over time. “Things” only do one thing: they cost money. Never spend cash on stuff that doesn’t have flexibility in returning your money down the road.
#4) Spending Your Extra Cash
When you get a raise or any form of extra income, it’s easy to think you have a permanent safety net. You might be making more money than ever before, have side-cash for home or car repairs, or even a little stashed away for vacation, but don’t let this extra money turn you into a high roller.
Whenever you’re accustomed to a certain lifestyle, it’s always difficult to scale back once you retire. Instead of living the high life, you might want to consider scaling down now – at least for a few years. After all, smaller houses can mean a cheaper mortgage and more to invest.
Think of it as an investment of time rather than money. Living cheaply for a few years, while earning a lot of cash, will eventually make it easier for you to save money towards buying profitable assets.
Don’t let a high pay check trick you into thinking you can afford a swanky loft downtown. Just imagine the money you can save if you choose to live in a place half the price, while saving the other towards the future.