Retirement planning takes discipline and hard work. Even the best-laid plans can fall by the wayside, and even the most dedicated retirement savers make a few mistakes.
The good news is we can minimize mistakes and correct slip-ups, starting with a few common retirement planning scenarios. Let’s take a look:
1. You allow averages to dictate your thinking and become too important to your savings strategy.
You make it a point to keep up with retirement planning and investing news. You read an article about average 401(k) account balances and delight in your realization that your own 401(k) balance is well above average for investors your age. Consequently, you assume you’re in great shape and decide to leave your account alone. You don’t bother to regularly increase your contribution level or revisit your investment lineup to see if changes are in order. After all, you’re ahead of the game and there’s nothing else you need to do. Right?
Wrong. Whether it’s a default contribution amount or ignoring your investments after you select them, adopting a set-it-and-forget-it mindset for your retirement plan at work can cost you dearly. For example, Frank and Tina each earn an annual salary of $50,000 and start contributing 5 percent to their 401(k) on the same day. However, Tina increases her contributions by 1 percent each year until she reaches the recommended rate of 15 percent. Frank continues saving 5 percent annually and never boosts his contribution rate.
Assuming a 5 percent annual rate of return and an investment period of 40 years, Tina’s balance will be $745,608.70 when she retires at age 65, while Frank’s balance at the same age is $301,999.44. Tina’s nest egg is worth $443,609.26 more than Frank’s because she made small changes each year to the amount she saved. She didn’t assume that because she was ahead of the curve, she didn’t have to do anything else to achieve her retirement goals.
The takeaway: Set annual reminders to increase your contribution rate by at least 1 percent, keeping in mind the annual contribution limits for work retirement plans. It’s likely you won’t feel the difference in your paycheck, as the impact on your nest egg will be noticeable once you reach retirement.
2. You assume a 1 percent annual increase in your contribution level puts you on a great trajectory for retirement wealth.
I know what you’re thinking. I just said that 1 percent annual increases are a great way to get you closer to your retirement goals. Here’s the thing, though: Although regular boosts to your contribution rate can make a huge difference, it might not be enough for you. Individual investors have different income needs in retirement, and as a result savings goals can vary widely.
Using the above example, it might seem Tina is well on her way to a successful retirement, but maybe she expects to live 30 plus years after leaving the workforce, and perhaps she has a long bucket list of what she wants to accomplish in her golden years. If what she really needs to save for retirement is closer to $1.5 million, increasing her contribution rate by 1 percent annually – no matter how noteworthy – won’t add up to a nest egg big enough for her to live the retirement lifestyle she envisions.
Tina shouldn’t rest on her laurels of saving an additional 1 percent each year. By making some changes to her budget – dining out a little less, buying fewer clothes and cutting her cable package – she could make larger periodic increases to her retirement account. For example, a 2012 survey found that two-thirds of American workers buy lunch during the workday, spending an average of $1,924 annually on their daily Chipotle or McDonald’s run.
By cutting the cost of her lunch habit in half, Tina could contribute an additional $962 to her retirement account. That one-time investment could potentially add more than $6,772 to her portfolio in 40 years’ time (assuming a 5-percent annual rate of return). That may not seem like much, but if she keeps up the habit (by annually investing the $962 in lunch savings), she could watch it add more than $122,020 to her retirement fund over the same time frame. That’s no small potatoes.
The takeaway: Small changes to your lifestyle can free up the funds to add to your nest egg. Although these amounts may seem insignificant at first, over time they have the potential to really add up, thanks to the power of compounding interest. Make it standard practice and watch your nest egg grow without too much effort on your part.
3. You consider yourself a more-than-competent saver and disregard many of the other resources available to you.
Tina’s probably feeling pretty good about herself at this point. Problem is, she still hasn’t figured out how to accumulate the $1.5 million she needs to fully fund her retirement. She’s so confident in her own ability to save money, in fact, that she doesn’t pay too much attention to her investment lineup – after all, saving money will get her closer to her goals than investing ever could. Right?
Wrong again. Saving money is a crucial part of the equation, yes, but investing remains an equally important way to achieve your dream of a comfortable retirement. Someone like Tina – a great saver, but a little unsure of her abilities to pick the right funds – could likely benefit from a little help.
An Aon Hewitt and Financial Engines study published in May that looked at the impact of online advice, managed accounts and target-date funds in defined contribution plans from 2006 to 2012, showed that investors receiving this "help" achieve median annual returns more than 3 percent higher than investors who did not.
Since Tina’s investing with her employer-sponsored 401(k), she should take advantage of any in-plan advice offered, whether provided through her company as an employee benefit or through the plan administrator. If in-plan advice is unavailable, she could also look into out-of-plan options such as online advice.
The takeaway: Advisory services can help you pick the most appropriate funds (and the percentage to invest in each) to best support your risk tolerance, timeline and personal goals. And in Tina’s case, increasing her annual rate of return from 5 percent to 8 percent as a result of getting help would increase her total nest egg to $1,496,224.47. In other words, she’s pretty close to reaching her savings goal of $1.5 million.
A majority of 401(k) plan participants say their 401(k) plan is their sole or largest source of retirement savings. But as you can see, it’s not enough just to invest your money in these plans. To better take advantage of the opportunities they offer, do your best to avoid these common retirement planning mistakes. Not only will you avoid sabotaging your primary retirement savings vehicle, but with a little forethought and planning, you could get even closer to the retirement of your dreams.
This post is part of Smart401k CEO Scott Hollsopple’s contribution to the U.S. News & World Report Smarter Investor blog series. To view the original article, click here.