The Top 6 Easily Avoidable Retirement Mistakes
We all work hard to plan for retirement. In any such endeavor, it’s good to learn from other people’s triumphs and mistakes, so I’d like to share six retirement mistakes I see all too frequently. The best part is, they’re easily avoidable!
#6: Not getting the most out of Social Security.
I’ve seen different statistics reported, but the fact is that way too many Americans don’t max out their Social Security. I’ve seen it reported as 2% or 4%; just to be safe, let’s say only 10% of Americans actually receive their maximum Social Security benefits. That means 90% of us are leaving money on the table when it comes to Social Security. I know not everybody can wait until age 70 to get their maximum Social Security check, but it really shouldn’t be 90%, right? Every year we don’t collect Social Security, we get an 8% increase in delayed retirement credits—8% per year!
If you Google “top fears of retirees,” #1 on every list is “fear of running out of money.” What’s the best way to guarantee we won’t ever run out of money? Max out your Social Security income. But people think, “You know, I’m 62, I’m retired. I can start collecting now.” It’s human nature to collect money as soon as it becomes available, but I think it’s a big mistake. And collecting early because you’re afraid Social Security will collapse? No. Because Social Security is funded through a dedicated payroll tax, as long as people are out there earning money, Social Security can never run out of money.
There’s a second part to this mistake: many married people forget about survivorship benefits. Let’s say I collect $1500 and my wife gets $2000 a month. Regardless of which of us passes away first, the bigger check stays. If my wife dies first, the $1500 check goes away and the $2000 check becomes the one check, regardless of who that amount is attached to; that’s the survivorship benefit.
Plan ahead to max out your Social Security. Delay as long as humanly possible.
#5: Overestimating our ability to be objective about own investments.
I think the bull market has spoiled us a little bit as investors, and some of us are getting overly confident about our ability to be objective about our portfolio. It’s easy to think, “Oh, I know the market’s going to go down eventually, but when it goes down, I’ll harness my intestinal fortitude and I’ll be able to ride it out. I just know it.”
Or we may lack the objectivity to notice our own greed. “Hey, you know, Netflix is up 70% over the last however long, I think it’s going to keep running. I’m not going to rebalance. Lets let those ponies run.” We get overly confident about our investing aptitude, and it affects our diversification. I’m biased, but one way to avoid this mistake is to hire a financial advisor who knows a thing or two about portfolio management. Personally, I’d go with my company, but there are 300,000 financial advisors who can do that for you. However, I know most of our audience belongs to the do-it-yourself crowd, so I’ll give you some pointers about how to stay objective about your investments.
Use a model to set up your portfolio and let the model be objective on your behalf. Let’s use real estate as our example. Don’t take this as any sort of a specific investment recommendation; it’s just an example. Now, real estate has not had a very good year, but it has done well in the past. Let’s say real estate is a broad investment option in your 401K or your IRA, and you set that investment percentage as 5%. So, real estate has an iffy quarter; let’s say it goes down something like 20%. Now you’re have a 4% real estate allocation. You look at that 4% and say, “That’s down 20%—it’s not worth putting more money into.” But you had decided on 5% real estate allocation to keep your portfolio properly diversified. What’s changed?
What you should do is rebalance. Sell some of your winners or put more cash into your portfolio (if you’re still in accumulation mode) and get that allocation back at 5%. Here’s when the fear kicks in and you’re not willing to pull the trigger, right? Unless you’ve laid this plan out ahead of time, you’re not objective enough about your investments, and you flinch.
The reverse is also true. If real estate does really well, and that 5% creeps up to 5.5%, or 6%, or 7%, we’re looking at a gain of over 30%! This is where you need to not be greedy and trim that position back to 5% even if you think it’s going to go up and keep going up forever. Rather than becoming overconfident, you need to trim it back to 5%. This becomes very difficult if you make a decision in the moment when that investment is cooking and running on all cylinders. A natural greed kicks in—but it’s always going to crush you in the long term.
So, whether your investment is up or down, if you decided 5% is an appropriate allocation for portfolio diversification, keep it at 5%. Rebalance at least annually, getting those positions back to your original model allocation. Maybe even set tolerances (what percent above or below you will rebalance), but decide those ahead of time.
Be proactive with your investment portfolio, rather than reactive. If we react to the sentiment of the market, we’re likely to let those ponies run too far, or neglect to feed our losers on a dip, and we will regret it in the long term. Lock in your ability to be objective about your own investments.
#4: Not having a retirement rehearsal.
Every single year, over 50 billion dollars of unused vacation pay—50 billion!—is completely squandered because people don’t take vacations, especially on the run up to retirement. At this stage, you’re getting paid as much as you’ve ever been paid in your career, and that encourages you to work overtime or do everything you can to maximize your income and contribute to your retirement accounts. Unused vacation pay isn’t about your 401K or your budget, but I believe it’s a crucial retirement planning tool, and it’s being completely ignored.
When we think about retirement planning, the first thing people talk about is that big bucket list item. I’ve got a friend right now who traveling to Morocco, and that’s a wonderful thing to plan for, a great retirement incentive.
It’s just basic behavioral finance to save towards that big dream we want. But let’s boil it down. If you spend the first month of your retirement in Australia, that represents maybe 0.0002% of your actual time in retirement. Even though those big dreams are great motivational tools, I believe that, from a financial planning perspective, it’s more useful to plan for a random Tuesday afternoon when you’re watching Grey’s Anatomy on Netflix with your spouse, because that is going be 99% of your retirement.
I advocate taking that unused vacation now. Take two weeks off from work and have a staycation. Don’t go anywhere; just spend time at home doing your hobbies. At the end of two weeks, you’ll have experienced one of two things. One, you’re bored, and that’s a huge red flag. If you’re completely bored, you haven’t figured out what you’re going to retire to, and you’re likely to spend a whole bunch of money out of boredom and blow up your retirement budget. So, if you’re bored during retirement rehearsal, what do you do? First, keep working for now, and second, find something to retire to.
Alternatively, you might discover is that you are totally content in your retirement rehearsal. You pursue relatively low-cost leisure activities or volunteer opportunities. You look at your retirement budget and say, “Gosh, I was planning on spending $7000 a month in retirement, but after this two weeks of retirement rehearsal, I realize that I’m probably closer to $5500 a month. That means we can probably retire a lot sooner than we thought.”
Your retirement rehearsal gives you new data to apply to your retirement plan. Take some of your unused vacation time to dodge this easily-avoidable retirement mistake! It’s a no-lose decision.
#3: Not using a war chest.
This ties in to #5, becoming overconfident with investments. I see people not using enough cash and bonds in retirement accounts. The standard retirement account is 60% stocks and 40% bonds, but if you haven’t been rebalancing, it could have crept up to 70%, 80%, or 90% stocks. You’ve been looking at your bonds and cash and thinking, “That’s not returning hardly anything and these stocks are cooking; I’m not going to rebalance just yet.”
You need to have a war chest of cash and bonds. Why don’t people do it? Because it’s boring. People think, “I could be buying a small cap, international growth fund, something that’s a little sexier, bonds are lame.” But sexiness is not the purpose of that cash and those bonds. They’re meant to provide us non-correlated returns to our stocks. Whether the market is good or bad, if you’re in retirement, you need cash every month, so we need some boring stuff in our portfolio in order to get us through those leaner times in the market. If you recently retired, or you’ve been retired over the last seven years, this bull market makes it easy to forget there are lean times and they could be right around the corner. Keep your war chest healthy to avoid this common mistake.
#2: Incorrectly assuming the path to retirement success is more about investing than planning.
I’m a firm believer that we can’t invest our way to a good retirement. We need to plan our way to our ideal retirement. Investments distract us from planning. There are always interesting debates: “Should I use active management or passive management, or buy alternative investments, or what’s this long-short fund, or what’s this annuity product I hear so much about that makes sure I can never outlive my income?” We spend way too much time on technicalities that don’t really matter in the big picture. If you don’t have a reason to retire, you start pursuing unhealthy activities out of boredom. That has much more impact on your retirement than earning five basis points because you decide to buy DFA’s large cap growth instead of Vanguard’s. Besides distracting you from what’s important, spending money on expensive investments is going to cost you thousands of dollars per year if you have an average retirement portfolio.
Please focus on what you can control. You can control your own behavior, but you can’t control what the market does. You also can’t invest your way to fulfillment or contentment. You need to find out what it is you’re trying to accomplish in life, because that has a much bigger impact on your retirement verses what stocks and bonds you’re invested in.
#1 most easily avoidable retirement mistake: Not using a dynamic spending strategy.
So, what’s a dynamic spending strategy? Well, it’s deciding ahead of time what’s going to happen to your portfolio income when the market falls apart. Let’s say you’re taking out $5000 a month. You don’t think of that sum as a certain percentage of your portfolio; you just think, “Oh, $5000 a month should last me 30 years, so I’m just going to close my eyes and hope I never hit a $0 balance.” That’s probably not the best way to plan your way to your ideal retirement, consider using a dynamic spending strategy.
As long as you use a reasonable initial withdrawal rate, a dynamic spending strategy can ensure you don’t run out of money. It works like this: you decide ahead of time, “If my portfolio drops below this number, I’m going to reduce the amount I’m taking out. If it drops below the next number, I’ll reduce it again.” You dynamically adjust how much you withdraw based on current portfolio values. In doing so, you are being proactive rather than waiting for the market to misbehave and then reacting to it.
Let’s say your account balance is a million dollars and you’re taking out X% per month. Choose a number that’s 20% above your current balance and say, “If the market does well and my million dollars becomes $1.2 million, I can give myself a spending increase of 10%.”
What if the market declines? If the market is bad, or even flat, and you’re taking out money every month, eventually you need the market to cooperate, or your portfolio will eventually fall to $800,000. If you’re proactive about your dynamic spending strategy, you decide, “Okay, at $800,000, I’m going to reduce my spending 20%, from $5000 down to $4500.”
The dynamic spending strategy is one of my favorite financial planning techniques. I love to sit down with clients, show them a simple Excel spreadsheet and tell them, “If your portfolio does this, here’s how we’re going to react. If your portfolio does this, on the downside, here’s what we’ll do.” I tell them, “This is about financial planning. We don’t need to use fancy variable annuities and expensive investing products. Financial planning has nothing to do with some fancy hedge fund strategies that cost an arm and a leg. It’s about focusing our energy on things we can control.”
You can control a lot of factors that make your retirement wonderful, and you can learn from other people’s mistakes. Get the most out of Social Security; commit to making objective investment decisions; have a retirement rehearsal and learn from it; keep your war chest healthy; know the value of planning over investing; and use a dynamic spending strategy.
If you’re looking for a financial advisor to help you stay accountable, we are accepting clients in our firm this year. Contact us today for additional details.
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