Financial Mistakes to Avoid as You Approach Retirement

Jane Young, CFP, EA

Jane Young, CFP, EA

As you enter your 50s it becomes increasingly important to incorporate retirement planning into the management of your finances.  Your 50s and 60s will probably be your highest earning years at a time when expenses associated with raising children and home ownership may be tapering off.  It’s crucial to take advantage of the opportunities during this time to shore up your retirement nest egg.

One significant retirement mistake is the failure to assess your current financial situation and understand how much is needed to meet your retirement goals.  Many underestimate the amount of money required to cover retirement expenses which may result in delaying retirement.   Consider hiring an advisor to do some retirement planning and help you understand your options, how much money is needed, and what trade-offs may be required to meet your goals.

Another common mistake is to move all of your retirement funds into extremely conservative options, as you approach retirement.  With the potential of spending 30 to 40 years in retirement, it’s advisable to keep a long term perspective.  Consider keeping your short term money in more conservative options and investing your long term money in a well-diversified portfolio that can continue to grow and stay ahead of inflation.  As you approach retirement, it’s also important to avoid making emotional decisions in response to short term swings in the stock market.   Emotional reactions frequently result in selling low and buying high which can be harmful to your portfolio.

Many in their 50s and 60s have more disposable income than at any other stage of life.  Avoid temptation and be very intentional about your spending.   Avoid increasing your cost of living with fancy cars and toys or an expensive new house as you approach retirement.  Instead, consider using your disposable income to pay down your mortgage or pay off consumer debt to reduce your retirement expenses.

Another common pitfall is spending too much on adult children including your child’s college education.  The desire to help your children is natural and admirable but you need to understand what you can afford and how it will impact your long term financial situation.  Place a cap on how much you are willing to contribute for college and encourage your kids to consider less expensive options like attending a community college or living at home during their first few years of college.   They have a lifetime to pay-off reasonable student loans but you have limited time to replenish your retirement funds.

Finally, a failure to care for your health can be financially devastating.  If you are healthy you will probably be more productive and energetic.   This can result in improved job performance with more opportunities and higher income.  If you are in poor health, you may be forced to retire early, before you are financially ready.   You also may face significant medical expenses that could erode your retirement funds.

Defending Yourself Against a Market Correction

Jane Young, CFP, EA

Jane Young, CFP, EA

The recent increase in the stock market is making a lot of investors nervous about the possibility of a significant correction.  I am frequently asked what the market will do over the next few months.  In reality, no one can predict market performance, especially in the short term. Your best defense against a volatile stock market is to create a financial plan and an asset allocation that is appropriate for your financial situation and time horizon.

If your current asset allocation is in line with your financial goals, there’s probably no need to make major adjustments to your current portfolio.  Your asset allocation defines the percentage of different types of investments such as U.S. stock mutual funds, international funds, bond funds and CDs that are held in your portfolio.  You should establish an asset allocation that corresponds with the timeframe of when your money will be needed.   Investments in the stock market should be limited to money that isn’t needed for at least 5 to 10 years.  Keep money that may be needed for emergencies and short term expenses in safe, fixed income investments like bank accounts, CDs or short term bond funds.

The stock market is inherently volatile and there will be years with negative returns.  However, over long periods of time the market has trended upward with average annual returns on the S&P 500 exceeding 9% (approximately 7% when adjusted for inflation).  It’s important to consider your emotional risk tolerance in establishing your asset allocation.   You may have the time horizon to have a significant portion of your portfolio in stocks but you may not have the emotional tolerance.  Your asset allocation may be too risky if you are tempted to sell whenever the market goes down or you are continually worried about your investments in the stock market.

Establishing an asset allocation that meets your situation can help your ride out fluctuations in the stock market more effectively than trying to anticipate movements in the market.  It’s impossible to time the market and a short term increase is just as likely to occur as a drop in the market.   Although you want to avoid timing the market, you should rebalance your portfolio on an annual basis to maintain your target asset allocation.  Additionally, you will want to adjust your target allocation over time as your financial situation changes and you move through different phases of life.

Keeping other areas of your financial life in order can also help you through a major market adjustment.   It’s essential to maintain an emergency fund of at least 3 to 6 months of expenses,  make a habit of spending less than you earn, and  save at least 10 -15% of your income.

Rather than focusing on where the market is headed and what the financial pundits are predicting, maintain an appropriate asset allocation and keep your financial affairs in order.

Understanding Stock Market Indexes

Jane Young, CFP, EA

Jane Young, CFP, EA

A stock market index provides a benchmark from which you can measure the performance of the stock portion of your portfolio.  An index statistically tracks the movement of a specific grouping of stocks.  There are numerous indexes that range from monitoring performance of the entire market to specific sectors of the market.  When referencing an index it’s important to understand what comprises the index and how the stocks are weighted.

The oldest and most widely followed index is the Dow Jones Industrial Average (DJIA), founded on May 26, 1896 by Charles Dow.  It is comprised of 30 stocks from a wide range of industries with the exception to transportation and utilities.  The 30 stocks comprising the index are selected by editors of the Wall Street Journal with the goal to show a true reflection of the market by focusing on relevance, longevity and market representation.

The DJIA isn’t actually an index but a price weighted average where more expensive stocks represent a higher proportion of the index and have more influence on the movement of the index than lower priced stock.  Originally, the DJIA was an average of the sum of the prices on all stocks in the index divided by the total number of stocks.  However, over time the calculation has been adjusted to account for stock splits and dividends.

Currently the DJIA represents about 25% of the total value of the U.S. stock market.  Although it only represents 30 widely known companies, over the long term it tracks well with the S&P 500 and can be a good measure of large company stock performance.

The S&P 500, another widely known index, was created on March 4, 1957 by Standard and Poor’s and is now part of McGraw Hill Financial.  It is comprised of 500 U.S. companies chosen by a committee at Standard and Poor’s with an objective to represent the U.S. stock market based on “market size, liquidity and group representation”.  It excludes companies that invest in real estate and companies that primarily hold stock in other companies.  Currently the index is solely comprised of U.S. companies, primarily but not limited to large companies.  The S&P represents about 75% of the value of the U.S. Stock Market, providing a much broader picture than the DJIA.

The S&P 500 is a market-cap weighted index where the weight in the index is based on the total value of all outstanding stock in the company.  As a result, large companies have much greater influence on movement in the index than do small companies.  About 50 of the 500 stocks in the index represent half of the total market capitalization within the index.

There are numerous other indexes available to monitor performance on specific sectors, smaller company stock and international stock.  For example, the Wilshire 5000 Index is a total U.S.  market index covering almost all publicly traded U.S. companies and the Russell 2000 Index covers the 2000 smallest publicly traded U.S. companies – both of which are capitalization weighted.

Words of Wisdom from Planners Around the Country

Jane Young, CFP, EA

Jane Young, CFP, EA

While recently attending the national conference of the Alliance of Comprehensive Planners, I interviewed dozens of fee-only, Certified Financial Planners.  I asked them to share the most important piece of advice that they can give to their clients.  The answers were not exciting or complicated but practical, common sense recommendations that are useful to most everyone.   The most common piece of advice, by an overwhelming margin, was to save more and spend less.  Below are the top ten most important financial steps you should take according to some of the finest financial planners in the industry.

  1. Live Below Your Means – Establish good spending habits early. Monitor your expenses for about three months and create a realistic spending plan that you can stick with.  Make intentional decisions to keep your spending well below your income and always maintain an emergency fund.
  2. Save at Least 10% of your Gross Income – Start saving as early as possible. Everyone should save at least 10% of their income.  If you are getting started later you may need to save closer to 15% to 20% of your income
  3. Look at the Big Picture – Take an integrated approach to your finances. Your financial life is a big puzzle with a lot of interlocking pieces.   Don’t make decisions in isolation.  Create a financial plan that serves as a roadmap to integrate all areas of your financial life including investments, taxes, insurance, retirement planning and estate planning.
  4. Be True to Yourself – Live, spend, and invest in accordance to your values and goals, not to impress or compete with others.
  5. Create a Realistic Investment Plan – Create a diversified investment plan that you will stick with during significant market fluctuations. Your portfolio needs to support your investment time horizon and the level of risk that you are comfortable with.
  6. Hire a Good Financial Planner – Managing your finances can be more complicated and time consuming than you realize. A financial planner can help you integrate all aspects of your financial life and can provide an objective perspective on your situation.
  7. Don’t Invest in Complex Insurance and Investment Products – Avoid insurance and investment vehicles that require a team of attorneys to understand. The words in small print are probably not in your best interest.
  8. Maximize Contributions to your 401k and Roth IRA – Fully utilize tax advantaged retirement plans and take advantage of an employer match where available.
  9. Don’t Let Family Members Derail Your Financial Plan – Don’t sabotage your financial security by paying for all of your child’s college education or by supporting adult children, parents, or siblings. You need to help yourself before you can be of assistance to others.
  10. Leverage Your Real Estate – Don’t be in a hurry to pay off a low interest mortgage on your personal residence. You can benefit from appreciation on your home with as little as 10% to 20% down.
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