In 2017, retirement planning is a complex animal.
Unfortunately, you don’t have the luxury to work at a company for 30 years and then collect a generous pension plus social security until you die.
It is much different today!
You have to be responsible. You have to understand the difference between Roth IRAs and 401(k)s. You have to assume a rate of return accurately, so you know how much to save.
There is a laundry list of things you must get right so you can eventually retire.
However, statistics show the majority of Americans have about the same odds to retire comfortably as I do to see the bags under my eyes magically disappear.
Here are some sobering numbers from MarketWatch.com when it comes to retirement in the United States:
- The median working-age couple has only $5,000 saved for retirement
- The median couple in their late 50s/early 60s has only $17k save in a retirement account
- 43% of working-age families have NO retirement savings at all
I assume you aren’t one of the statistics as the above group, but there is a good chance your retirement plan is seriously flawed.
5 Reasons Your Retirement Plan will Fail
1) Assumed the Wrong Rate of Return
Nothing pisses me off more than listening to “experts” like Dave Ramsey and David Bach tell you to expect a 12% on your investments. This advice is the equivalent of telling you to eat a #4 large-sized at McDonald’s and assume you are are only consuming 150 calories.
It won’t work!
The reason assuming 12% is dangerous is because your planning numbers will be considerably off.
Let’s say you are 35 and want to retire in 30 years with $500,000 saved.
When you use Ramsey’s magical 12% return, then the numbers show you only need to save $1,770 a year or $147 a month.
Saving $147/month is relatively easy!
When you use a more realistic number like 7%, then you need to save $5,100 a year or $425/month.
Earning a 12% return on your investments every single year is difficult. In fact, the only person I know who did this was Bernie Madoff.
Assuming a high rate of return will destroy your chances of coming close to retiring.
Here is where it becomes dangerous. Let’s suppose you think you can get the 12% return Unicorns get and plan to save $147.
Now we fast-forward 30 years, and you only earned a 7%. You would have about $178,000 in your account or $322,000 short of your goal.
See how dangerous assuming high rates of return can be in your planning?
To ensure you are saving enough, use a more moderate return like 7%. When you are more conservative with your investments, you’ll have a more realistic chance at accurately planning for retirement.
2) Substantial Fees
Another area most people ignore is the fees they pay for their investments.
The vast majority of investors blindly invest in mutual funds because that is the norm. There are three problems with most mutual funds:
1) According to many studies, the total fees for mutual funds exceed 3%
2) They are really expensive
3) They are really expensive
Let’s see what how investing $100,000 over 30 years in mutual funds compared to index funds can affect your portfolio value. We assume you are paying 2% more in fees for your mutual funds.
At the end of 30 years, you would have 42% more in your index funds than your mutual funds; or about $330,000.
The difference is real!
To avoid falling trap to the mutual fund scam, look at investing in index funds or ETFs. These types of funds aren’t typically ladened with fees.
3) No Diversification
Often when people invest in 401(k) plans, they pick a few mutual funds and never look back. If a company matches your contributions, then the match usually comes in the form of company stock.
There are two major problems here:
1) If you initially set up your 401(k) plan to invest in three funds and have been at the company for 5-10 years; then your portfolio is heavily overweighted.
Let’s say you have been investing in an S&P 500 fund, a Mid-Cap fund, and a G&I fund. After ten years, you would have a portfolio densely invested in large-stock funds (think Apple, Microsoft, and large banks).
This portfolio could easily take a 20% or 30% loss in a bad year. Your portfolio lacks foreign investments, bonds, small caps, real estate, etc.
2) For simplicity, let’s assume your company matches dollar for dollar in company stock for the first 5% you contribute. If you have contributed $50,000 over the past ten years, then your organization has contributed the same amount in company stock ($50,000).
Half of your portfolio would be in company stock. Having 1/2 your money in your organization is dangerous. Do you remember Enron?
It’s easy to keep your money in the stock because you have confidence in where you work. However, anyone can lose money by having too much confidence in where they work. I lost over $30,000 by investing and being too confident in the organization where I worked.
Keep your money diversified and limit company stock to 20% of your portfolio.
4) Too Safe
Maybe you are a conservative investor and want to keep your money “safe.”
If you fall into this category, then you probably invest your money in ultra conservative money market funds. Money market is just a fancy term for a savings account that won’t keep pace with inflation.
When you are investing your money in savings accounts or money markets you can expect an average return of maybe 2-3% a year. You won’t lose money, but you aren’t going to grow it either.
Investing $5,000 for 30 years into a “safe” money market account earning 3% will give you a total of $245,000. Investing that same amount in a conservative, diversified portfolio earning just 6% will give you a total of $419,000.
Make sure all of your money isn’t sitting in cash. It’s hard to save enough to retire comfortably without growth.
5) No Plan
People don’t plan to fail; they fail to plan.
This reasoning is the same for retirement planning. It’s difficult to know what you need for retirement if you don’t know when you want to retire, how much you need for retirement, and how long you think you’ll live.
It’s never too early to start planning. The worst mistake you can make is ignoring your retirement planning.
There is no doubt planning for retirement is not easy! In fact, you can take a million wrong turns.
However, if you can assume the correct rate of return, limit fees, diversify, avoid investing in all cash, and plan a little bit; you will be ahead of 95% of families.