It takes decades of sound planning and good decisions to enjoy a comfortable retirement. Unfortunately, even the best of us can make mistakes that impact our financial lives in our golden years. It’s therefore essential to know about those common mistakes and their consequences if you don’t want your retirement fantasies to become financial catastrophes.
Failing to Start Early with Retirement Planning
A common mistake investors make is that they don’t realize why retirement planning is important and often wait too long to make retirement plans. The importance of early planning becomes apparent when you think about the power of compound interest, which Albert Einstein once called “the eighth wonder of the world”. Each year that you wait to begin your retirement savings cuts your final nest egg in half, making your golden years a lot harder to fund.
Many people delay retirement planning thinking retirement is still far and intangible at an early age, or because they figure they can catch up later with increased contributions. An individual who saves $200 a month at age 25 and earns a 7% annual rate of return will have around $545,000 at age 65, while another person who postpones starting the same savings plan until age 35 will have around $245,000. This extreme disparity is the reason why early planning is non-negotiable.
The late beginning also becomes even more difficult when you factor in the fact that older workers tend to have greater expenses, family obligations, and potentially lower earning potential, so catching up is nearly impossible. At retirement, this miscalculation means not having enough income to live the lifestyle you want, forcing you to make the hard choices between necessities and standard of living. Working with a professional fiduciary financial planner makes a lot of sense here, but even then, the mathematical reality of the situation is that time is your greatest ally when it comes to planning for retirement.
Falling Victim to Lifestyle Inflation Throughout Your Career
Lifestyle inflation or lifestyle creep is one of the most insidious retirement security dangers since it feels natural as your income grows. This is a mistake that occurs when people increase their consumption proportionally or more than the increment in their salaries. And this results in very little money left for retirement savings even though they’re making more now.
The issue is that the higher income creates an illusion of wealth, which often makes you think you have more disposable income than you actually do. You’re also going to fall prey to the problem called “lifestyle inflation” when you want to improve your standard of living once you taste any success in business.
Instead of factoring in the long-term impact of this on retirement, people justify costly buys, high-end services, and luxury goods as “earned rewards” for their labor. Peer comparison and social pressure fuel this impulse, as individuals feel compelled to keep up appearances proportionate to their income.
In retirement, the effects of lifestyle inflation become a reality when retirees realize that their savings can’t keep up with the enhanced lifestyle they have become accustomed to. Contrary to the working life where income somehow rises, retirement income is mostly static, and it’s not possible to pursue costly habits without quickly draining savings.
This forces retirees to make radical changes in lifestyle at the very time they are not emotionally and physically capable of adjusting to radical changes. The harsh disparity between pre-retirement and retirement standards of living is bound to result in stress, depression, and a lower quality of life during what should be the golden years.
Making Emotional Investment Decisions
The thrill ride of market timing is perhaps the most expensive error investors commit, founded on fear in falling markets and greed in rising markets. People tend to buy in rising markets due to optimism and sell in falling markets due to fear, the exact opposite of prudent investing. It’s usually the consequence of excessive confidence in one’s capacity to anticipate market activity and relying too much on the myth that patterns of past performance always foretell future outcomes.
Market timing is attractive to investors because it guarantees the best returns and offers a feeling of having control over investment results. Yet even professional investors struggle to time markets successfully, and retail investors who try to use this strategy end up significantly underperforming buy-and-hold strategies.
If you mess up your market timing when you retire, you may have to suffer big time because you don’t have much time to recover from losses, and it’s often hard to substitute lost savings with an income. And trying to actively time the market can be a hassle and a time-consuming task, which is not always the best thing for your health and happiness in those later years of life.
Taking Early Withdrawals from Retirement Accounts
The temptation to withdraw money from retirement funds early is a self-sabotaging error that snowballs in the future, eliminating long-term retirement security. Individuals rationalize premature withdrawals for seemingly valid purposes, like house purchases, college tuition, or short-term economic downturns, totally ignoring the long-term numerical effect on their retirement timelines. In reality, the short-term economic benefit of premature withdrawals obscures the enormous opportunity cost and penalty consequences.
Early withdrawal features usually come at times of economic hardship when individuals feel that they have no choice. The ease with which 401(k) loans and hardship withdrawals can be made gives these accounts the impression of easily accessible emergency funds, but it’s an illusion to the true intent of retirement savings. Individuals are also concerned about the ready availability of money and ignore the tax and penalty implications of these early withdrawals.
The retirement implications of early withdrawals reach much farther than the immediate tax and penalty, though. When you make early withdrawals, you end up losing the original sum along with decades of possible compound interest on that money. In retirement, this means reduced monthly income, which may compel retirees to work longer, move into a smaller home, or rely on relatives for help.
Underestimating Healthcare Costs and Inflation’s Impact
Another costly mistake in retirement planning is about discounting how healthcare expenses and prices are going to increase over a 20 to 30 year retirement. Unfortunately, most people lowball how much they are going to need for medical expenses when they’re retired, assuming Medicare will pay for all of it, but that just never seems to be enough for actual healthcare needs.
This mistake occurs usually because medical expenses are unexpected and typically look reasonable during working years when employer coverage provides substantial protection. The retirement reality of underestimating medical expenses can be financially catastrophic. This compels people to make impossible choices between healthcare and necessary living costs, or deal with rapidly depleting savings intended to last an entire retirement. The fear of financial insecurity contributes to health problems, rapidly deteriorating physical and financial well-being of a person.
Endnote
Learning about these five mistakes is the secret to having a reliable retirement plan that can withstand whatever life throws your way during your golden years. No matter how knowledgeable you are, you can always make mistakes, which is why you must learn about them in advance to be able to prepare in advance and achieve your retirement goals with confidence.
