Retirement is something that most working people hope to eventually achieve, but planning for retirement isn’t always easy. Many different variables, such as the future cost of living, your life expectancy, the housing market, etc., need to be accounted for. It can be challenging to know just how much you’ll need in order to live the rest of your life comfortably.
There are many different financial strategies, products, services, and investment opportunities that will be presented to people planning to retire. But, as you might expect, while some of these investments will make a lot of sense, others will not be nearly as lucrative.
Money traps to avoid when retirement planning
Finding ways to avoid these common “retirement money traps” will inevitably make the entire retirement planning process much easier. The more you know, read, and ask about — and understand the financial sector — the better off you will be.
So, what are the most common retirement traps being faced today?
This article will discuss some of the most common challenges, money pits, and ineffective strategies affecting the modern worker. We will review if it’s smart to invest in a business for yourself or discover more about the people you should trust to help you make end-of-life financial decisions.
By making a deliberate effort to understand these common hazards and avoid them throughout the retirement planning process, you can better position yourself to achieve your long-term financial goals.
1. Waiting to save for retirement
When you are young, you likely have many expenses, which makes having early financial goals crucial. For example, in the class of 2019, about 69 percent of students graduated with some type of student loan debt (averaging about USD 29,000 per person).
Other early-life expenses, such as weddings, a down payment on a house, and childcare, can also quickly begin to add up. You might also want to spend your younger years traveling, which can be both fulfilling and expensive.
With many potential expenses being faced by people under 40, long-term financial goals like retirement are often pushed to the backburner.
However, waiting even just an additional few years to save for retirement can be very consequential down the road. For example, a million-dollar retirement portfolio, growing at five percent per year, yields fifty thousand dollars per year.
This means that waiting one year to begin saving effectively takes away fifty-thousand dollars from your future self (not that you currently have a million dollars — just sayin’).
Starting small — even just a few hundred dollars per month — can deliver big dividends in the future. Additionally, be sure to see if your current employer offers any retirement contribution or matching programs.
Choosing to forego these programs essentially leaves free money on the table.
2. Extending your debt
Many people wrongly assume that just because they can access higher debt levels, it must be in their best interest to actually do so. However, maxing out all sources of borrowing will negatively affect your credit score, but it will end up costing you significant amounts of money over time. According to Experian, debt held by American consumers is approaching 4 trillion dollars — a problematic all-time high.
Having access to debt can be useful in case of emergencies and to help build your credit over time.
Some types of debt, like a mortgage, are seemingly unavoidable. However, to the greatest extent you possibly can, you should try to quickly pay down your debt. This is especially true if the amount the debt is growing (measured in APY) is greater than the returns you can receive from investing in the market—when this is the case, you will be effectively losing spending power as time goes on.
3. Overactive trading
Many people engage in day trading and other short-term trading strategies to beat the market and build wealth over time.
New platforms like Robinhood and WeBull have helped spark a trading revolution, especially among young people. The S&P 500 produces an average annual return of about 14 percent per year. Beating this average return is something that many active traders can certainly do, but choosing an overactive trading strategy can create unforeseen issues for aspiring savers.
To start with, short-term trading is taxed as ordinary income rather than being taxed as capital gains.
If you engage in too many trades, you will quickly begin to accumulate near-term tax obligations, which as a result, will decrease your actual rate of return. I’m not suggesting you never engage in any sort of short-term trading or active trading strategies. However, it is important to be mindful of the risks you are taking and the obligations you are pursuing when doing so.
If doubling your money overnight was really so easy — just about everybody would be doing it.
4. Low-return accounts
In finance, risk and reward are typically correlated with one another, meaning that you will need to accept lower rates of return if you want your money to be safe. Likewise, anyone who wants their money to grow at a faster rate will need to be willing to take some risk.
Because few people want to “risk their life savings” when planning for retirement, it is not uncommon for people to choose investments (and wealth storage vehicles) with minimal downside.
Usually, this results in people distributing their wealth in accounts that offer very low, but guaranteed rates of return, such as a savings account, federal bonds, or certificates of deposit (CD).
However, some accounts issue rates of return that are so low; they are hardly even worth considering. For example, in the United States, the average savings account distributes a dismal 0.07 percent interest rate. Considering that the average annual inflation rate is around 2.46 percent (for all years 1990-2018), this means that choosing a traditional savings account will cause to effectively lose money over time.
Some accounts, particularly online banking options, offer much better rates. But even still, it is important to realize that low-return, “risk-free” investments actually carry with them a tremendous opportunity cost.
5. Lack of liquidity
When saving for retirement, many people will become entirely fixated on “their number.” They will come up with a number (or asset allocation strategy) that they believe can last them for the rest of their predicted lives and then once they have reached this number, they will consider themselves “ready to retire.”
Having a ballpark estimate of what your lifetime expenses might be can obviously be very helpful. However, not all large sums of money should be considered equally. In addition to the number itself, there are other factors, like liquidity, that will need to be considered.
Liquidity is a term used to describe how easily a prospective asset can be converted into spendable cash.
Your home, which likely represents a very significant portion of your total wealth, is generally considered an illiquid asset because it would take time to convert your home into any sort of cash you could actually use.
Of course, I’m not suggesting you not invest in or live in a permanent home. But, ask yourself, “If the answer is a clear no, then you may want to reconsider how you structure your portfolio.”
6. Not preparing for the Required Minimum Distribution (RMD)
According to the IRS, “Your required minimum distribution is the minimum amount you must withdraw from your account each year.” The RMD that applies to any given individual will depend mostly on their age, along with a few other possible factors.
The IRS specifically addresses several different types of retirement plans the RMD affects.
This article first appeared on Entrepreneur.