With the decline of pensions and the rise of healthcare costs in America, the safety of one’s financial future is in their own hands now more than ever. One can argue that the concept of retirement may be different in the near future compared to the traditional image of sitting on a beach sipping on a pina coladas (aka doing nothing). Many even think about “working” in retirement.
Here in the United States, the current “full retirement age”, according to Social Security, is 67 for those born after 1960.
If you’re at work in an office right now, take a moment and look around and try to identify how many people around you are even older than 62 (the age you can start first taking social security). It’s probably not that many, if any at all.
For many companies, older people just aren’t as employable or desired as those younger and middle-aged. Now even if you do have some co-workers who are older in age, how many of them do you think are happy to work or want to be there? I would guess even less.
Why You Need Retirement Accounts
There are numerous advantages to saving money in a retirement account like a 401k or IRA. First, and most important, is that it will allow you to pay for your living expenses when you either don’t want to work or can’t work, which will one day come whether you want it to or not.
Second, they provide tax advantages so that you get to keep more of your money and pay less in taxes. How big your nest egg needs to be when you retire is a more complicated question, however, it’s safe to say for most people, they would like to have more rather than less saved up for the future.
The Biggest (And Most Obvious) Mistake
The biggest mistake with retirement savings is simply not starting. Obvious right? (Stay tuned for a less obvious mistake…)
There are several mental blocks many people have with getting started saving for retirement. One is simply the fact that for many people, the idea of retirement is so far away and not worth thinking about right now. But another reason is simply being hesitant to open an account like an IRA because they’re not sure where to open one or what to do after it’s opened.
For something like an IRA, there really are a lot of options out there on where you can open one and it can lead to analysis paralysis resulting in inaction. 401k accounts are generally a little better these days, especially at larger companies, where they are opened automatically for you and usually contribute a certain percentage of your salary by default.
Common Advice Given
So let’s say you’ve gotten over the initial hurdle of opening your retirement account… what is the biggest mistake you can make then?
Google this question and most of the top results you’ll get back is to make sure you’re contributing enough to your 401k to get your company match. “It’s free money!” they always claim. While this is true and definitely important, it won’t apply to everybody.
First, this will only apply to 401k and not IRAs. Small companies or ones with mostly non-exempt workers sometimes don’t even offer 401k accounts. Additionally, a lot of companies that do offer them sometimes don’t even offer a company match. So for all these scenarios, the often given advice of contributing enough to your 401k to receive your company match is not applicable.
The Next Biggest Mistake
The power of retirement accounts not only lie in their tax benefits, but also in the ability for their holdings to be invested appropriately as one sees fit.
The biggest mistake you can make with your retirement accounts is not investing the money appropriately for your age.
A lot of people confused or intimidated by opening a retirement account may consider opening the account and contributing money into it a big enough win.
BUT PLEASE DO NOT STOP THERE.
Often times when opening an IRA for the first time, if you do not make an investment selection for your initial contribution, the IRA administrator may default the contribution into a money market fund. What happens then is for subsequent year’s contributions, you will just see your money sitting in a money market fund and once again default to contributing into it. This is a horrible perpetual cycle where you’re just diligently pouring your money in year after year into a money market fund earning 0.5-2% return.
“BUT LOOK, I’M SAVING!”
That’s great, saving money is good; but having your money grow is even better. Historically, the average inflation rate is approximately 2.5-3% each year, so if you’re earning less than a 3% return on your money, you’re actually losing money due to inflation. In 30 years time, the value of $1 could only have the buying power of 50 cents today. In order for that $1 to have the same buying power in 30 years, it needs to become at least $2 in 30 years.
For companies offering 401k accounts, the situation is a little better. In the past, companies would offer 401k accounts, but not many employees would sign up for them. Why? LAZY. UNINFORMED. NO URGENCY. So eventually companies started signing up all their employees for 401k accounts and automatically contributing a small percentage of the employee’s salary in the plan.
GREAT! The problem now was that since most people couldn’t be bothered to see what their contributions were being invested in, or god forbid to even change how their contribution was being invested, companies defaulted contributions to a predetermined investment fund.
One Size Does Not Fit All
When it comes to investing, one size does not fit all. If we’re talking about being invested in just one fund, someone in their 20’s should not be investing in the same fund as someone in their 40’s or 50’s. A person with a longer outlook until retirement should be more heavily invested in stocks than bonds.
To solve this issue, 401k administrators started offering Target Date Funds, which offer age-appropriate diversification between stocks and bonds. Now companies could default your contributions to the appropriate investment fund based on your age. This is where we’re at now.
So do me a huge favor… If you have an existing retirement account like a 401k or IRA (or both), dust off that long lost login and password and have a look at what you’re invested in. If your money is 100% invested in a money market fund or bond fund, you need to change your allocation immediately. For those that want the simplest solution, move your money to a Target Date Fund corresponding to your expected retirement age. If you’re more savvy with your investing, create a diversified portfolio that is appropriate for your age.
Let me know down in the comments below if you just realized your retirement account was not being properly invested. If you like this article and want to be notified of more helpful financial advice, please sign up for my newsletter down below.