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by: Emma Snow
Wealth seems to be everyone's dream; the ability to relax
a little more, to not stress so much about finances and to
enjoy the "good life." So often it is believed that
wealth is only attainable by those with large incomes. Those
with smaller incomes may not put anything aside, assuming
such small savings won't make enough of a difference in the
long run. In my experience in the financial services industry,
there were several times when I would help an elementary school
teacher or janitor with their sizeable 403(b) account. Obviously
for them, small savings over time made a big difference. In
the same category are those who have large incomes and assume
they always will. They constantly spend to the top of their
income level and set little or nothing aside for the future.
Yes, I also remember helping doctors or attorneys take loans
out of their 401(k) accounts. I found that it wasn't so much
what you made but everyday decisions that determined long-term
success.
When I once asked a janitor of an elementary school how he
had accumulated his 1.7 million dollar 403(b) he said, "I
just started putting money into it when I first came to work
here, a little bit each paycheck." Now, 40 years later
as he approached retirement with a steady pension and a large
403(b) account he was financially wealthy. Avoiding financial
mistakes is the key for anyone to retire well. This article
lists some of those mistakes and ways to steer clear of them.
Waiting Until You're 55
Not starting to save soon enough is number one on our list.
Beginning early to save for retirement can make a huge difference
in the long run. To illustrate this, let's assume we have
two people saving for retirement, we'll give them simple names
that correspond with the age they started saving, Mr. 25 and
Mr. 45. Mr. 25 puts $3,000 into an IRA each year until he
retires at age 65. Assuming he gets an 8% growth rate on average,
he amasses $839,343 or almost a million dollars by age 65.
If Mr. 45 were to put the same amount aside but start at age
45 instead of 25, he would only have $148,269 saved, definitely
not enough to start retirement with. For Mr. 45 to end up
with the same amount as Mr. 25 he would have to save almost
$17,000 per year until age 65. $17,000 per year for 20 years
equals $340,000 cash out of pocket, whereas $3,000 per year
for 40 years is only $120,000. Mr. 25 only had to save about
one third the amount Mr. 45 did all because he started early.
Letting compounding do the work for you allows you more money
for other things you want.
1% Is Enough, Right?
Putting aside too small a percentage of income is another
mistake people make. It may be difficult when just starting
out and times are lean, but you will thank yourself in the
long run if you make this a priority. Going back to Mr. 25
again from above, if he would have only put away $1,000 each
year, his ending balance would have only been $279,781 in
40 years, again assuming the 8% growth rate. We know how much
$3,000 per year would have saved him, but what about $6,000
per year? He would have $1,678,686. Doubling his savings doubles
his end result.
I'm a Millionaire!
Not realizing just how much needs to be saved in order to
retire is our next mistake. While the 1.6 million in the above
example may seem like a lot of money, it won't pay the bills
in 40 years. Assuming prices go up by 3% each year, 1.6 million
will only have the buying power of a half a million dollars
in 40 years when Mr. 25 wants to retire. Assuming Mr. 25 lives
to the ripe old age of 90, a 1.6 million dollar account will
give him about $2,300 dollars of income each month in real
terms. This assumes that he earns 6% on his money after he
retires. Does it seem odd that our 1.6 million dollars is
now only worth $2,300 dollars per month? Inflation is the
culprit. In actuality Mr. 25 will be getting about $9,800
dollars out of his account each month in retirement, but because
prices for everything will be so much higher in 40 years it
will only be able to buy the same amount that $2,300 dollars
buys today. This is what "real terms" means. Mr.
25 will have to determine if $2,300 per month will be enough
to live off of in retirement. Most likely it will not be enough
unless he really likes ramen noodles.
Do I Get a Checkbook with my 401(k)?
Using Retirement Accounts as income before retirement is
becoming a mistake that more and more people are making. This
is especially true for those who have employers contribute
to their retirement accounts. While it is tempting to assume
this is just extra money you can spend, it has terrible long-term
effects. Taking as little as $5,000 out of your retirement
account at age 30, is like taking out $35,000 in 35 years.
If it would have been allowed to stay in the account and grow
over 35 years, it would have accumulated to almost $35,000.
The other problem is that you will most likely have to pay
taxes and a 10% penalty on the money because it is being taken
out before age 59 1/2. Now to get $5,000 after the taxes and
penalty, you have to take out over $8,000, which would equal
over $55,000 lost in 35 years.
I'm Sure my Basket Can Hold All of This
Not Diversifying or putting all your eggs in one basket is
another financial blunder. I was a retirement specialist working
with 401(k) and 403(b) account owners when the market crashed
in 1999 and 2000. How vividly I remember talking with people
in their fifties and sixties who in February of 2000 (right
before the NASDAQ started falling) wanted to put their entire
retirement account into technology. I discussed with them
the advantages of diversification especially in such a volatile
market. Some listened, but most didn't. The comment I remember
the most is, "I don't have enough money to retire so
I need it to grow really fast." The result was buying
in at an all time high and then either jumping out along the
way down or riding the market to the bottom. Those who stayed
in for even a year lost more than half of their retirement
in a technology fund.
Compare that to those who were diversified across several
markets, domestic and international, and several types of
investments, equity, fixed-income and short-term. Someone
in their fifties, planning on retiring in 10 years would be
diversifying if they had about 60% in stocks and the rest
in bonds and money markets. This type of portfolio still lost
money during that volatile time, but not nearly as much as
a technology fund did. Those with a diversified portfolio
lost about 5-15% in that same time period that the technology
sector lost 50-65%. Trying to earn money for retirement by
putting all your eggs in one basket, especially when you are
close to retirement, is almost as risky as using the slot
machines in Las Vegas. If you are behind in your savings,
your best bet is to start contributing the maximum allowed
and push back retirement for a few more years.
Won't Uncle Sam Take Care of Me?
Relying solely on Social Security will leave you with little
income in retirement. In a message to the public issued by
the Social Security and Medicare Board of Trustees in 2005
they stated, "We do not believe the currently projected
long run growth rates of Social Security and Medicare are
sustainable under current financing." They went on to
say that without major changes to Social Security, it will
begin to fall short in 2017 and will only be able to fund
74% of benefits by 2041. The suggested solution is to either
increase taxes 15% or decrease benefits 13%, neither of which
are good for retirement. To continue to live the same lifestyle
that you are accustomed to, saving for retirement is essential.
Another Trip to the Doctor?
Not preparing for healthcare in retirement is something that
we have recently had to think about. There is a good possibility
of Medicare not being able to meet our needs in the future
or we may need our own health insurance to carry us until
Medicare kicks in. Being prepared to pay for premiums or medical
expenses in retirement is becoming a necessity. A 2004 study
found that an average retiree spent 22% of their income on
healthcare costs. For someone on a $50,000 a year retirement
income, this equates to $11,000 per year. Take that over a
25 year retirement and you are up to $275,000 for healthcare
costs alone. Long-term care such as nursing homes or in home
assistance is another cost that should be prepared for. With
less and less employers covering healthcare in retirement,
this is another area that is often overlooked when planning
for the future.
Avoiding these financial mistakes will determine your quality
of life in retirement. The next step is to get started. There
are many brokerage firms that will educate you about your
options at no cost. They can help you open a retirement account
or determine if you are contributing enough to your current
retirement account. The can also help you decide on what types
of investments are appropriate given your age, timeframe and
risk tolerance. The most important thing to remember is that
it is never too late to start saving and even a little money
set aside makes a big difference in the long run.
About The Author
Emma Snow is a writer who specializes in financial planning.
She has worked in the financial industry for over eight years.
Currently Emma works on a Finance and Investing site at http://www.finance-investing.com
and Investing Partners http://www.investing-partners.com.
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