Avoiding the Most Common Retirement-Planning Mistakes

We often learn more from our mistakes than from our successes. But making mistakes with money can be costly — literally. So it’s far better, if possible, to learn from other people’s mistakes.

Two years ago, investment firm Natixis surveyed 2,700 financial professionals worldwide about the most prevalent mistakes they’ve observed regarding retirement planning — errors and oversights people commonly make about later-life financial preparation. We’ve detailed several of those common errors below.

• Underestimating the impact of inflation.

The survey of financial professionals tagged this as the single most common retirement-planning mistake. Just as most people don’t fully appreciate the power of compounding in the long-term growth of an investment portfolio, they also fail to grasp the destructive impact of inflation’s compounding.

Although inflation is generally discussed in terms of “higher prices,” price increases result from what is truly happening: the devaluation of money makes it lose “purchasing power.” That’s why what used to cost, say, $75, now costs $100. It’s because the money is worth less than it used to be.

Even with a relatively tame rate of inflation, the compound effect over many years destroys considerable purchasing power. Consider the situation 20 years from now if inflation grows at just 3% a year: Today’s $75,000-a-year lifestyle would cost $135,000. That’s $60,000 additional dollars to achieve or maintain roughly the same standard of living provided by $75,000 today.

• Investing too conservatively.

This error ties directly to the inflation-related point above. To meet the challenge posed by inflation, one must invest in instruments that have the potential to match or outpace inflation. Although fixed-income instruments such as CDs, bonds, and savings accounts serve essential functions within one’s overall financial holdings, they are ill-suited for beating inflation. That’s why investing too conservatively can be quite risky.

• Overestimating investment income.

A realistic retirement plan should consider your potential longevity (see next point) and use return projections that aren’t overly optimistic. Withdrawing too much money too soon from your retirement account(s) will create problems later, especially if you or your spouse live to a ripe old age.

A general rule is that withdrawing no more than 4% annually from your portfolio will ensure the account isn’t depleted early. However, the “4% rule” isn’t always optimal. Your personal “safe withdrawal rate” depends on several factors, including other sources of income, the size of your portfolio, and the sequence in which your investment returns occur.

• Underestimating your life span.

As SMI noted in a recent article, even though the average life expectancy in the U.S. is 76 years, a man who reaches age 65 in good health has a greater than 60% probability of living to age 85. A 65-year-old woman in good health is more likely than not to live into her 90s.

Therefore, for many people, making wise financial preparations for their retirement years must take into account two decades or more of life after age 65. Again, it is impossible to know how those years will play out concerning investment performance and inflation. However, failing to plan for 20 or more years of retirement and not considering the range of possibilities is asking for trouble.

• Forgetting healthcare costs.

In the U.S., Medicare covers many — but not all — health expenses for people 65 and older. Generally speaking, Medicare covers routine medical costs (including some preventive care) and short-term hospital stays. Covering other expenses with insurance requires purchasing a supplement plan (Medigap) or a Medicare Advantage plan, and you’ll likely face out-of-pocket expenses for co-pays and other things such plans don’t cover. Many plans, for example, don’t include dental coverage.

Of course, the biggest health-related wild card in retirement planning is the potential cost of extended care. Insurance policies that cover long-term care have grown prohibitively expensive for most people, but a more affordable short-term-care policy may be an option. For those who qualify for a Health Savings Account, building up an HSA during one’s working years can help fund later-life health costs.

Remember that one of the best ways to prepare for later-life health is to take good care of yourself today. Many common health issues result from poor diet, lack of exercise, too little sleep, too much stress, and other controllable factors.

Take advantage of helpful resources

Because so many variables change over the years, it is difficult to anticipate everything that might happen. Fortunately, resources are available to help you avoid common errors and oversights.

One is MoneyGuide, the award-winning web-based financial planning tool available to SMI Premium-level members. MoneyGuide can run hundreds of “what if” scenarios, taking into account variables such as market reversals and higher inflation rates.

Additionally, you may want to seek guidance from a financial professional, such as a Stewardship Advisor at SMI Private Client (a separate business from the SMI newsletter, although the two businesses are affiliated).

In an unpredictable world, no retirement plan will work out perfectly. But by thinking carefully and taking advantage of helpful resources, you can go a long way toward securing your financial future.

Image used with permission