If you’re regularly contributing to retirement savings, you’re leaps ahead of the one in three Americans who have $0 saved. But even automatic contributions throughout your working career can leave you struggling to make ends meet throughout your golden years.
To ensure you’re not coming up short on retirement savings — or worse, unwittingly sabotaging your future retirement — stamp out these common habits.
1. Spending Now Rather Than Saving for Later
It’s much easier to focus on the present than to think about the future, said Erik C. Olson, a certified financial planner with Arete Wealth Management. After all, when bills are due, finding room in your budget to save for retirement might not seem as important.
But if you take a good look at your spending, you likely can find ways to trim the fat so you can set aside more money for the future and actually retire someday. For example, Olson said you could lower your monthly expenses by hundreds of dollars by dining out less, opting for a cheaper cellphone plan, cutting the cost of cable TV — or eliminating it — and getting rid of credit card debt.
“Maybe you’re thinking, ‘Well, that wouldn’t be as much fun,'” he said. But ask yourself how much fun it would be to work the rest of your life because you can’t afford to retire.
The sooner you start saving, the more time you’ll have to grow your money. “What you save and invest in your first five to 10 years can grow to be the majority of your portfolio at retirement, even if you keep saving and investing for decades more,” said Olson. “Compounding growth is that powerful.”
2. Underestimating How Much You’ll Need to Retire
Maybe you really are keeping your spending under control so you can save for retirement. But, your efforts might not pay off if you haven’t bothered to figure out how much you will need to live comfortably in retirement.
“To avoid being caught off-guard when that day comes, get with a capable financial planner … to get a clearer picture and a plan in place,” Olson said.
At the least, use an online calculator, such as Vanguard’s retirement income calculator or the Fidelity MyPlan Snapshot, to get a general idea of how much you need to save.
3. Only Investing in the Best-Performing Mutual Funds
Michael Hardy, CFP with Mollot & Hardy, said he often sees people pick the mutual fund in their 401k lineup that has the best performance record, hoping that it continues to climb as it has in the past. It might seem like a logical strategy, but it’s actually a mistake.
“What history shows us is that, over time, the best performers will become the worst, and the worst, the best,” he said. “You may jump in at the top and find yourself getting out of that fund as it is crashing.”
Instead, choose a target-date fund, if your retirement plan offers them. These funds keep your money diversified among stocks and bonds, and get more conservative as you get closer to retirement, Hardy said.
4. Misunderstanding What Diversification Means
You’ve heard that your portfolio should be diversified. So, as you make your investment choices for your 401k, you might think it’s a good idea to spread your money across the 10 best funds, Olson said.
Those funds, however, might have a good track record because they were invested in the same sort of stocks or bonds that performed well recently.
“What you might have gotten was portfolio concentration disguised as diversification,” he said. So if one starts tanking, they all could, and you’d have a portfolio meltdown.
Avoid this mistake by doing your homework, asking for help from your plan’s advisor and learning how to build a truly diversified portfolio that fits you, Olson said.
5. Saving Only When the Market Is Doing Well
If you’re only setting aside money in a retirement account when the market is up, it means you’re paying a premium because stock prices are higher.
“This is actually the worst time to put your money into your retirement account,” Hardy said.
Rather than try to time the market, he said you should have a set amount deferred from every paycheck to your retirement account. Increase that amount as you can afford to do so.
6. Overreacting to Market Volatility
It’s hard not to be tempted to pull all of your money out of stocks when market downturns deal a blow to your retirement savings. But this is one time you need to put the brakes on your emotions.
“It’s easy to get emotional when you turn on CNBC and see nothing but red,” said Shannon McLay, founder of The Financial Gym. “But you need to try to stop yourself before trading in your retirement accounts as a result. Even if you are close to retirement, you need to have patience. As long as you have the right asset allocation and a rebalancing strategy in place, you will be fine in the long run.”
History shows that the markets bounce back, she said. And so will your portfolio. It might mean you have to delay retirement by a few years. But that’s better than cashing out your retirement account after it’s taken a big hit because there’s no way it will bounce back if you’re not invested.
7. Putting Contributions on Auto-Pilot
You don’t pull money out of your retirement account when the market’s down or only invest when the market is up. You also don’t want to set your retirement contributions entirely on autopilot, said Marguerita Cheng, a CFP with Blue Ocean Global Wealth.
If your retirement plan doesn’t automatically increase your contribution rate annually or you don’t increase it yourself, you might be at risk of not saving enough for a comfortable retirement. Most experts recommend saving at least 10 percent to 15 percent of wages annually.
If you can’t contribute that much, make sure you’re setting aside enough in your 401k to get any matching contributions from your employer. Then, set aside more each year as your income rises.
8. Making Only Pretax Retirement Contributions
You get an immediate tax benefit by contributing pretax dollars to a 401k, 403b or similar plan because this lowers your taxable income. And contributions to a traditional IRA or SEP can be tax-deductible.
“At first glance, it seems like this approach uniformly would be the smart move, since you’re immediately avoiding taxes, and therefore probably can contribute more,” Olson said.
This approach, however, overlooks the fact that when you withdraw this money in retirement, it will all be taxed as ordinary income. If you think your tax bracket will be higher by the time you reach retirement, it makes sense to invest in a Roth IRA, Olson said. You don’t get an upfront tax break with a Roth IRA, but withdrawals in retirement are tax-free.
9. Not Factoring in Rainy Days
If you’re channeling all of your savings into a retirement account but haven’t set aside money for emergencies, you could be putting your retirement savings at risk. That’s because you might have to raid your retirement account to keep yourself financially afloat if you lose a job, can’t work due to an illness or have a big, unexpected expense.
“To avoid being caught off-guard, develop a rainy day emergency fund to cover the risks you can afford, and put some basic insurance policies in place for the ones you cannot afford,” said Olson. “This can help you not only get through the rainstorm — or hurricane — but may also help you keep your retirement plan closer to being on track.”
10. Putting Too Much Money Toward a House and Car
If you own a car and house, you’re likely in the habit of making payments for them. But have you fallen into the habit of overpaying by buying more house or car than you can afford? If so, there might not be much room in your budget to save for retirement.
“Cutting your housing and auto expenses by 25 percent will have more of an impact on your long-term retirement savings than if you never bought another coffee or enjoyed a dinner in a restaurant for the rest of your life,” said Vincent Wagner, CFP.
You might argue that if your home is paid off by the time you reach retirement, that’s one expense you won’t have to worry about. But you won’t be able to afford the upkeep, insurance and utilities if you don’t have enough retirement savings.
So, you might need to downsize now to a less expensive home. Or, trade in a pricey vehicle for a used one that you can buy without financing. Then, boost retirement contributions by the amount you’ve saved on housing and car costs.
11. Paying for Your Kid’s College Education
It’s understandable that you want your child to get the best college education possible.
“But many families overestimate the value of the more expensive schools and underestimate the deterrent to their own retirement savings stemming from either saving for these colleges in advance or saddling themselves with enormous student loans,” Olson said.
Making it a habit to save for your kid’s education is great if you’re not doing so at the expense of your retirement savings. But if you can’t afford to save for both, remember that there are no loans for retirement.
“And don’t be ashamed or feel like you’re cheating your kids if you impart to them early in life an important lesson about weighing benefits and costs,” said Olson.
12. Tapping Your Retirement Account for Cash
If you’ve gotten into the habit of tapping your retirement account for cash — to pay off debt, buy a car or make a down payment on a home — you could be putting a serious dent in your savings and taking on a big tax bill.
“First, your retirement savings is now smaller, and you forfeit all the compounding,” Olson said. Then, you’ll have to pay taxes on any withdrawals from a 401k or traditional IRA, and a 10 percent early withdrawal penalty if you’re younger than 59 ½. You can, however, withdraw contributions to a Roth IRA tax- and penalty-free.
If, for example, you prematurely withdraw $25,000 and are in the 25 percent tax bracket, you’d owe $6,250 in federal income taxes and another $2,500 in early withdrawal penalties, leaving you with a net of only $16,250, Olson said. If you had left that $25,000 to grow for another 25 years with a 6 percent annual return, you would have more than $107,000.
13. Withdrawing Money Too Quickly in Retirement
Your savings might not sustain you through retirement if you’re withdrawing too much each month. If you’re withdrawing more than 3 percent of your nest egg each year, “you may be too optimistic about how generously both market returns and inflation will treat you during retirement,” Olson said.
To ensure your money will last, you might need to scale down your lifestyle expectations. Or, you might need to work more so you can funnel more into your retirement accounts and delay tapping your savings.