Managing your finances is a balancing act between spending for today and saving for the future. It’s important to plan and save for retirement but the demands of everyday life frequently get in the way. Here are some common pitfalls to avoid when planning for your retirement.
Living Beyond Your Means – Spending more than you earn, failing to save and going into debt can be huge threats to your financial security and retirement plans. Develop a spending plan that allows for an emergency fund and annual savings of 10-15% of your gross income. Make a conscious decision to spend less money, buy a less expensive house and buy less expensive cars to keep your expenses below your income. This can help you save for the future with a buffer for financial emergencies.
Failure to Participate – Participate in tax advantaged retirement plans for which you may be eligible. Contribute to your employers 401k or 403b to take advantage of any employer match and deduct the contributions from your current income. Additionally, if you are eligible, consider contributing to a Roth IRA. Generally, an after tax Roth IRA contribution can grow tax free, with no tax due upon distribution.
Failure to Diversify – Maximize the potential for growing your retirement nest egg by maintaining a well-diversified portfolio designed to meet your unique risk tolerance and investment timeframe. A common pitfall is the failure to monitor and rebalance your portfolio on an annual basis. A portfolio that is too conservative can be as detrimental to your retirement plan as an overly aggressive portfolio. Upon retirement, investors frequently make the mistake of changing their portfolio allocation to be extremely conservative, when they may live for another 30 to 40 years.
Market Timing and Trading on Emotion – Moving in and out of the stock market based on short term market fluctuations generally results in lower long term returns. There is a natural inclination to buy when the economy is booming and sell when the economy is in the doldrums. This usually results in buying high and selling low, which can be very detrimental to your portfolio. To maximize your retirement portfolio avoid the emotional temptation to react to short term events and fluctuations in the market.
Funding College and Living Expenses for Grown Children at the Expense of Retirement – Avoid the pitfall of sacrificing your retirement to fund college education for your children or to make significant contributions toward an adult child’s living expenses. Students have many options to finance or minimize college expenses but you can’t take out a loan to finance your retirement.
Cashing Out or Taking an Early Withdrawal – When you change jobs, transfer the money from your employer’s plan to another tax deferred plan such as a Rollover IRA. This allows you to avoid paying significant income tax and a 10% early distribution penalty, if you are under 59 ½.