In study after study, 401(k) investors come up short of the amount they need to sustain a pre-retirement lifestyle during their golden years. The reason for the failure? Lack of planning. To avoid finding yourself in short of cash just as your leisure years begin, consider these six tips.
1. Have a Number in Mind
Conventional wisdom tells us that saving for the future is the key to a happy retirement. In keeping with this mandate, investors put money into tax-deferred retirement savings plans. If they manage to save the maximum permitted by the plan, they often turn to tax-aware investments in order to keep their nest eggs growing and their tax liabilities low. On the surface it sounds great, but is it enough?
Blindly pumping money into your investments and hoping for the best is not an intelligent way to plan. Instead of just looking at the amount risk they are willing to take or the amount they can afford to put away each month and using that as a guide for their savings, smart investors set goals. They figure out how much money they will need to save in order to fund their desired retirement lifestyle, and then they save and invest accordingly. (To help with retirement planning, check out 5 Retirement Plan Moves TO Make Before Year-End.)
2. Monitor Your Results
Having a specific hard-dollar goal enables investors to track their progress toward that goal and allows investors to make adjustments to their portfolios in accordance with that progress. Consider, for example, that for many years, mutual fund companies suggested that their 401(k) plans would deliver average returns of 8% per year.
This hypothetical rate of return suggested that, on average, investors would just about double their money every eight years. Unfortunately, average returns don?t always work out so well in real life. Consider, for example, the 10-year period from 2000-2010. Instead of doubling every eight years, 10 years of investing in a well-diversified stock fund like Vanguard Total Stock Market Index Fund delivered a paltry 2.45% average annual return. A $10,000 investment on January 1, 2000 was a measly $12,744 on December 31 2010, a decade later.
The lesson for investors is clear: watch your balance. If it isn?t where it needs to be, take action. Get more aggressive, save more, change investments, etc. Evolve your strategy to keep up with the ever-changing financial markets. (For another reason to review your retirement plan, read New Retirement Plan Limits For 2010.)
3. You Can Never Save Too Much
For years, mutual fund companies told 401(k) plan participants that investing less than 10% of their income per year was enough. ?Invest enough to get the company match? was another piece of advice. Some ?experts? even suggested that investors were saving too much. Those sentiments have fallen by the wayside. Today, some experts recommend that investors save 12-15% of their pre-tax income as a starting point. Increasing that rate each year is strongly recommended.
Common sense plays a role here too. We all know that a significant number of people reach retirement without having enough money. Yet, we never hear stories about retirees who find themselves awash in cash and wishing they had less of it. The bottom line here? Save more. In the worst-case scenario, you?ll have saved so much more than you need that you will be able to retire early. (For more information, read Top 4 Reasons To Save For Retirement Now.)
4. Investment Diversification
Generations of 401(k) investors were told that diversification among stocks/bonds/cash was the way to protect their portfolios. As we have learned, there are periods of time where this idea simply doesn?t work.
The next generation of investors would do well to diversify beyond the traditional offerings by allocating a portion of their assets to annuities, income generating real estate or other investments that are not correlated to stock market performance. (For more ideas on diversification, see Bear-Proof Your Retirement Portfolio.)
5. Don?t be Greedy
More than a few retirees have a significant portion of their wealth invested in their former employer?s stock on the day they retire. If they fail to diversify, they risk losing everything if/when the stock crashes. Similarly, investors often hold onto their investments even after the investments have risen significantly in value.
In both cases, there is value in learning your limits. If you have a princely sum in company stock, diversification is a great way to lock in your gains. If your other investments have done their job and you have enough of a nest egg to achieve your goals, move you money to more conservative investments. Remember that old saying about the value of a bird in the hand versus two in the bush! (For information on what to do when you have reached your goals, see 3 Ways To Make Your Retirement Funds Last.)
6. Have a Plan B
What if you do everything right but your investments still don?t work out? Move to Plan B. You can choose to work longer, you can choose to change your lifestyle, or you can choose to do both.
Changing your lifestyle may require that you cut back on things you like to do. It may require moving to a less expensive home. It may even require relocating to a less expensive city, taking a roommate or moving in with a relative.
Just as you should be monitoring your investments during your working years, you should also be considering your alternatives. By taking some time to consider your alternatives before you need to make a choice, you will have a plan and be ready to act on it if and when the time to choose arrives. (If you choose to work longer, see Working Longer: Will It Hurt Your Retirement.)
Investing in the Real World
The financial markets are an imperfect tool. Relying on them subjects your future to the volatile and unpredictable nature of the investment returns financial markets generate. Despite these shortcomings, the financial markets are the primary retirement savings generator for millions of investors. Accept what you cannot change, and take an active role in monitoring your investments and making the changes you can in pursuit of your goals. (To read more on how retirement investing has changed, see The Evolution Of Retirement.)
Source: http://sophisticatedignorance.net/2013/02/13/finance-401k-enrollment-time-heres-some-tips-sophi/
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