Who, me?

No one likes to admit they’re making (or have made) a mistake. Sometimes, you don’t even know you’re making one. Ever heard the phrase “You don’t know what you don’t know?” This applies to all aspects of life, including retirement savings. It might take someone pointing out your mistake for you to realize you’re making it. I wish someone had pointed out mistakes I had made with my retirement savings long before I realized them for myself.

Below are some common mistakes that people make when saving for retirement. If you don’t know about them, you can’t avoid them. Take a look and determine whether any of these things apply to you. If one (or more) does, decide if its something you want to change, and then make it happen (or not). Fixing these mistakes just takes a few minutes of your time. These simple behavioral changes can pay huge dividends in the long run, and will lead to a more secure retirement.

5 Common Retirement Savings Mistakes

#1 – Not starting.

When is the best time to start funding a retirement account? If you answered ‘today,’ you’re on the right track. If you answered ‘yesterday,’ even better. Use the power of compounding interest to build your wealth. Start saving early, and save regularly. Waiting until you have ‘enough’ will only make it harder to meet our goal of a secure retirement.

#2 – Letting emotions take control. 

The market is volatile. It will go down, guaranteed. It will also go up, guaranteed. If you listen to the hype and let your emotions affect your investment decisions, you’ll eventually lose out. That happened to me when I started. The market lost a lot, and I got scared, so I didn’t put any more money in. I could’ve bought funds pretty cheaply as prices dropped, but my fear told me not to risk my money. Looking back, I missed out on two years of compounded interest. Now I just ignore the market and contribute every month, whether the market is up or down. My retirement savings are automatic, and I don’t worry.

#3 – Taking unnecessary or too little risk.

When you are young, you can afford to be more aggressive with your investments. Investing in 100% stocks isn’t an unreasonable allocation. Investing aggressively can help build wealth rapidly. If something goes wrong, your savings have a lot of time to recover. Conversely, if you are young and have much of your money in bonds, you won’t earn enough to grow your investments. Inflation will outpace your growth, and you’ll actually lose money. In this case, you are not taking enough risk with your retirement savings.

As you get older, you need to shift more of your money into bonds, which tend to be safer investments. In general, as stock prices go down, bond values go up, so bonds can be viewed as a sort of safe-haven. The trick is to find an allocation that allows you to earn enough to grow your portfolio, but will not expose your savings to too much risk. One approach says that the stock percentage in your portfolio should equal 100 or 110 minus your age. So if you are 40, you should have between 60 – 70% in stocks, and the rest in bonds. This percentage will change (and be less risky) as you age.

An even simpler method is to buy a target-date or age-based fund. These funds provide a pre-set mix of investments that automatically get more conservative over time. I own Vanguard’s VTTHX in my Roth IRA. Right now, it has about 80% allocated to stocks. By its target date, it will only have a 45% stock holding. And, its already diversified (see below).

#4 – Failing to diversify.

You could think of this as #3b. If you put too many eggs in one basket, and that basket breaks, you’ve lost all of your eggs. It’s too much risk. This can be more of an issue in the private sector, where people get bonuses in the form of stock options in their company. Over time, an employee’s retirement savings can consist almost solely of a single company’s stock. If that company does poorly, much of the employee’s savings is gone.

Owning large-cap, mid-cap, and small-cap domestic index funds, a foreign equity (international stock) index fund, and a fixed income (bond) index fund in your 401(k) or IRA will expose you to all the diversity you need.  A target-date fund will even allow you to own all of that for a very low expense ratio (mine is .15% – again, see below).

#5 – Not paying attention to fees. 

You may have noticed that I recommended all index funds just now. An index fund is a passive fund that tries to replicate the returns of a certain index (the S&P 500, for example) by owning all of the same stocks/bonds within that index. There is no fund manager who picks which stocks get put in the fund. An actively managed fund, on the other hand, has a fund manager who is tasked with trying to pick winning stocks. That fund manager has to get paid, and all the costs associated with trading within the fund need to be paid as well. As a result, the fees charged for index funds are lower than those for actively managed funds (as a general rule). These fees are paid by you, so it definitely matters how much you are paying.

You can figure out what a fund’s fees are by finding its expense ratio. This is listed as a percentage, where each hundredth of a percent is called a basis point. Schwab’s S&P 500 stock index fund has an expense ratio of 9 basis points (.09%), while a real estate fund available through one of my plan administrators charges 160 basis points (1.60%). Over time, these fees can add up to thousands of dollars, so it is best to pay as little as you can. We’ll talk more in depth about fees in an upcoming post, and I’ll show you some graphs to illustrate my point.

What About You?

Again, if you’ve made any of these mistakes, there is time to fix them. I’ve been guilty of #1, #2, and #5 at some point in time, and have taken steps to change. Have you made mistakes with your retirement savings that aren’t listed here? What did you do to fix them?