Avoid these Common Retirement Mistakes
No matter how quickly or often things change – technology, cultural attitudes towards investing, the economy itself – we’ve found a few remarkably consistent trends across all clients throughout our years of wealth management. No matter whether the client is a relatively small account targeting retirement in 30+ years or one of our high-net-worth-individuals, young or old, risk-averse or aggressive: human nature remains a common thread across the spectrum of our clientele, and we’ve noticed a few common mistakes that you can easily avoid when you’re planning for retirement.
- Strategically time your contributions to maximize your retirement wealth.
- Avoid cash as a deliberate investment decision and considering the effects of inflation.
- Continue to emphasize equities in a retirement portfolio despite higher fixed-income yields, especially when young, to maximize growth.
- Stay the course in stocks for long-term retirement portfolio success.
Don’t Wait or Deliberate
If you’re actively planning for retirement and set aside the annual maximum possible contribution towards your IRA or retirement plan, great – you’re already well ahead of many Americans. Still, you can (and should!) optimize your contribution strategy. Aside from working with your wealth management team to best allocate your portfolio’s assets, strategically timing your contributions is the number one way to maximize your retirement wealth.
Luckily, it’s also simple. So simple it seems as though it’d be common sense, but we’re often surprised at how infrequently clients follow this rule.
Contribute your annual limit as soon as possible and, ideally, on the first day of the year. Early contributions give your money the maximum time to grow. However, many clients still wait until the last minute to contribute. We find ourselves making calls in April to convince clients to contribute the previous year’s limit before tax time far more often than we prefer.
Let’s look at what happens when you contribute at the beginning of the eligible annual period for a Roth IRA, January 1st, compared to waiting until the last minute (April 15th of the following year). We’ll assume that we’re starting our portfolio today, investing the annual maximum ($6,500) at a relatively reliable 7% return typical of a traditional 60/40 portfolio:
Investment Period (Years)
Compound interest being what it is, it’s easy to envision what a stark difference early contributions are compared to procrastinating. If you can afford to do so and planned to contribute anyway, doing it today instead of tomorrow makes a massive difference.
Cash isn’t King
Now, we nearly always advise not relying on cash as a deliberate investment decision. Even for the most risk-averse clientele, there are much better alternatives to preserve capital with sufficient liquidity to enable active retirement withdrawals. Unfortunately, we often see a mindset driven by fear, uncertainty, and doubt that makes clients shy about stocks when markets are in a downswing. Stockpiling cash is the exact opposite approach we recommend, though, no matter how close to retirement you are or your risk profile.
We understand the tendency to keep cash at the core of your portfolio as you near retirement or if you are retired and actively withdrawing. But consider the effects of inflation; inflation is today’s watchword, so you’re likely sick of hearing about it. But inflation doesn’t trash cash only when it’s as high as today’s levels. Inflation is omnipresent, and while it might dip between high points, even a healthy 2% inflation rate reduces the actual value of your cash reserves daily.
As an aside, Treasuries (as a stand-in for a riskless investment) outperform cash when inflation is applied, even if only by a slim margin. When wealth managers refer to a cash position in your portfolio, they usually talk about “no-risk” investments like short-term Treasuries. Still, checking to ensure your account’s purchasing power isn’t dwindling due to inflation is best.
Furthermore, keeping cash can skew your calculations when projecting retirement savings requirements and planned expenditures. We don’t think that the 4% Rule is totally accurate, which we’ll look at shortly. Even as a good rule of thumb, though, holding cash destroys the model as your increasing withdrawal rate over time won’t match your portfolio’s value if it’s cash-heavy. The below table from a Stanford research study proves it: the top row shows the equities/cash portfolio blend, and the leftmost column is the withdrawal rate. Retirement failure is where they meet, so this table shows the likelihood of not having enough money through retirement if you over-rely on cash.
If you hold cash exclusively, you’ll see a guaranteed failure rate; failure rates drop nicely as you introduce an equity blend and demonstrates that even swinging for the riskiest allocation (100% stocks) through retirement still has good odds if you elect to stick to 4% withdrawals.
The standard advice for retirement planners is that the younger you are, the heavier you should weigh equities in a portfolio. We stand by that assertion: the longer your account has time and space to grow, the better. Riskier assets like stocks are the best vehicle to maximize that growth.
But faced with the prospect of surging rates where even high-yield savings accounts deliver 4%+ returns… well, the youth are forgiven for stacking cash in these and other high-yield, low-risk assets.
But the conventional wisdom that stocks are best the further you are from retirement remains true. Chasing yield isn't a fool's game, necessarily. Still, emphasizing short-term outcomes over long-term gains as the market rebounds while you've effectively dollar-cost averaged all the way down and ready to maximize the upswing… well, that is a bit foolish!
Remember, time in the market beats timing the market, especially when you have a long road to retirement. Couple a stock-heavy investment strategy with early contributions, as we hit previously, and you have a recipe for success in building a solid financial foundation with plenty of time to grow and mature.
Think of it another way: suppose your portfolio is worth $10,000, cash, and you can either buy a 60-month CD at 4.5% compounding or put it into a stock index ETF with these characteristics:
- Purchase price: $400
- Dividend yield: 1.6% (dividends reinvested)
- Average dividend growth: 5%
- Average annual return: 4.5%; this is somewhat conservative but represents the risk of a recession during the initial investment period.
When your CD reaches maturity, your portfolio is worth $12,462, but a stock index ETF over the same period is worth $13,596, and each share is now $477.
And, yes, you could use the CD’s balance to invest in the same ETF, but let’s look at that course of action compared to solely buying the ETF over ten years (we’ll also assume a more accurate 7% gain):
- CD, then stocks: $18,939
- Solely stocks: $21,125
- CD, then stocks: $140,344
- Solely stocks: $156,538
You get the idea. Chasing yield feels great, especially when stocks are as rocky as they are today. But, over a long-term retirement portfolio, short-term gain doesn’t come close to touching the benefit of staying the course in stocks – and this doesn’t even account for the liquidity issues with CDs! Even if you could perfectly time the bottom and park your cash in a CD while waiting, there’s no guarantee you’ll be able to sell the CD on a secondary market. If you do, you’re liable to be forced to sell at a discount.
Planning for retirement is a daunting task, but avoiding common mistakes makes all the difference. Through years of working alongside clients like you, we’ve noticed a few consistent trends that can impact retirement savings, regardless of age or risk profile.
By avoiding delayed contributions, overemphasizing cash positions, and not shying away from equities in a portfolio, you can optimize your retirement wealth. By contributing early and often, diversifying investments, and maintaining a long-term strategy, you can set yourself up for success in building a solid financial foundation for your retirement years.