As with so much in life, retirement planning is an exercise in which you win by not losing.
You don’t have to be the world’s greatest stock picker or the second coming of Warren Buffett. Given a lifetime of saving and investing, you can generally reach your retirement goals by simply avoiding a handful of easily avoidable mistakes that will cost you big when compounded over the years.
And I’m not talking about trading strategies or a “surefire way” to avoid the next bear market. I’m talking about basic planning that can be done by anyone with the basic skills to balance a checkbook.
So with no further ado, here are three easily avoidable mistakes that you should watch out for.
Retirement Mistake #1: Not Taking Advantage of 401k Matching
This might sound like an odd statement given my line of work, but the stock market is not always the best option for your investment dollars. If you have patience and the willingness to get your hands dirty, starting a small side business or buying rental properties can give you returns far in excess of what you can reasonably expect to earn in a 401k mutual fund portfolio.
That said, it’s hard to beat instant 100% returns. And that is precisely what you get when your employer matches your 401k contributions.
Look, unless you have a compelling investment opportunity that trumps the stock market — such as those small businesses and rental properties I was talking about — I recommend you max out your annual 401k contributions. In 2014, that amounts to $17,500. Realistically, you can expect something along the lines of 7% to 10% annual returns from your 401k, if history is any guide. But when your employer matches your contribution, you are getting instant 100% returns, not including any change in the market value of the investment.
You might not be able to afford to max out your 401k. For many Americans — and particularly young Americans — $17,500 is simply too much to part with in a given year. But you can afford to put in the 3% to 6% that your employer is willing to match. And if you can’t … well, you probably need to re-evaluate some of your lifestyle choices. That 3% to 6% compounded over a working lifetime can make the difference between retiring in style and moving in with your kids.
Retirement Mistake #2: Taking Social Security Payments Too Early
OK, this one might get a little morbid. But when you consider when to start taking your Social Security payout, you need to ask yourself how long you realistically expect to live. And I’m not talking about doctor’s estimates in a Breaking Bad scenario. I’m talking about a taking a realistic look at your family health history.
To what age did your parents and grandparents make it? Does your family have a history of heart disease or cancer? How is your health today? Have you lived a healthy lifestyle over the course of your life? Do you smoke — or did you smoke for a long period of your life?
This matters because taking Social Security early makes all the sense in the world if you have a relatively short life expectancy. But if you think that you might live well into your 90s, it makes far more sense to hold out for the larger benefit.
Take a look at this table provided by the Social Security Administration: Effect of Early or Delayed Retirement. And let’s use a person born in 1960 as an example.
A person born in 1960 is eligible for full Social Security benefits at age 67. But if you were to hold out for three additional years, you would be eligible for benefits that are 24 percentage points higher.
Let’s play with the numbers. Let’s say you’re eligible for $50,000 in annual benefits at age 67. That would mean that by age 70, you would have already collected $150,000 in benefits over the preceding three years. However, if you waited until age 70, you would be eligible for $62,000 in annual benefits. Thus, you would have to collect the higher $62,000 benefits for 12.5 years to “break even,” not accounting for the time value of money or any tax effects, and you would be ahead for any time after that. (In case you want to see the math, it looks like basic high-school algebra: 150,000 + 50,000x = 62,000x, where x is the number of years it would take to break even.)
So, if you reasonably expect to live well into your 80s, it makes sense to wait. If your family health history suggests otherwise … take the money sooner.
Retirement Mistake #3: Failing to Rebalance
The last easily avoidable mistake you should watch out for is failing to rebalance your accounts on a regular basis. An absolute nightmare scenario for any retiree is to build a retirement plan based on the assumption of, say, 4% annual drawdowns … then have a major bear market put your entire standard of living at risk.
Drawdowns of 4% are no problem at all in a raging bull market that sees the market rise 10% to 20% per year. But if you go through a prolonged bear market, taking regular drawdowns can dig deeply into the capital that you need to last for the next 20 years. The best analogy would be that of a farmer who eats his seed capital and then has nothing to plant come spring.
The traditional rule of thumb for asset allocation was to have the percentage of your portfolio allocated to equities equal to 100 minus your age. So, a 70-year-old retiree should have 30% allocated to stocks and 70% allocated to bonds and cash. (Owing to longer life expectancies, some planners suggest using 120 minus your age.)
There are a couple big problems with this rule of thumb. When it was concocted, bonds yielded significantly more than they do today. A bond portfolio yielding 5% to 7% was easily obtainable 15 years ago. That’s simply not the case today.
I would advocate a more flexible approach of gradually rebalancing your portfolio away from “growth-oriented” investments to “income-oriented” investments. This would include bonds, of course. But it would also include dividend-paying stocks, master limited partnerships, real estate investment trusts and even more exotic options such as buying investment properties or pursuing a covered call writing strategy. The objective is to build a growing stream of retirement income that doesn’t require you to spend down your principal.
But one world of advice here: Be wary of exceptionally high yields, as these can often signal danger. In 2012, I wrote an article warning investors to stay away from RadioShack (RSH) and to avoid being seduced by its then-10% dividend yield, as I expected it to be cut (it was). Alas, so was the dividend of one of the stocks I offered as an alternative, Spanish mobile giant Telefonica (TEF).
This brings up a complementary point: As you rebalance your portfolio toward income-oriented investments, be sure to diversify among both companies and industries. Plenty of income investors thought they were diversified in 2008 because they owned a large number of stocks. But it didn’t matter when a disproportionate number of them were banks that all ended up slashing their dividends during the crisis.
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long TEF.