Financial regrets? You’ve had a few, no doubt. When it comes to saving for retirement, it’s safe to say that most people would like to take back a decision or two, or turn back the clock and do some things differently. After all, we didn’t make much money right out of college, or had better things to spend our money on in our late 20s, or had kids to think about, rather than investing properly.
Here are three of the more common mistakes people make with retirement savings:
– Not getting an early start on 401(k) saving, and not contributing more
– Making high-risk investments
– Not creating a financial plan earlier
What’s interesting about the top three? They’re all intertwined.
Someone who doesn’t start contributing to a 401(k) earlier, or just forks over small sums in their 20s and 30s, is just the type of person who is going to be tempted to swing for the fences in his 40s to make up for lost time. The earlier you start, the less inclined you might be to make high-risk investments.
And if you’ve yet to create a financial plan, it’s obviously a whole lot easier to be either unaware of bad habits (shortchanging your retirement savings) or letting your emotions or greed get the best of you and pull you into a very high-risk investment.
Here are some workarounds to overcoming your biggest financial regrets:
Fix #1: Get more out of your 401(k)
There are no gold stars for merely contributing to your 401(k). What really matters is how much you’re forking over from each paycheck. A decent rule of thumb is that you want to be setting aside at least 10 percent of your pre-tax salary into the retirement fund. How are you doing?
If you’ve started at a new job in the past few years there’s a good chance your employer automatically enrolled you in the retirement plan and set a default rate of 3 percent or so of your salary. That is woefully low.
It’s time to up your contribution rate. Sure, maybe it’s not practical to double or triple your contribution rate in one quick move. Understood. But delaying is simply not an option either. Today’s the day you get past this big regret. Start by upping your contribution rate by two percentage points.
The next step is to commit to raise your contribution rate by at least one percentage point every year. A recent Deloitte survey reports that more than half of firms now offer an automatic-escalation feature for their 401(k) plans that will boost your contribution rate on a set date. The only problem is that most of the plans require you to sign up for this feature, rather than just making it a default setting for the plan. Check with your 401(k) to see if you can enroll in an auto-escalation plan. If not, you need to put a reminder in your calendar to do it yourself.
Now if you’re really heavy into the 401(k) regret and want to turbo-charge your retirement investing, the maximum you can contribute in 2012 is $17,000 if you’re under 50. If you’re 50 or older, your contribution limit is a sizable $22,500 this year.
Fix #2: Devise a long-term financial plan
It’s taken the increasingly influential field of behavioral finance to explain a vexing truth of 21st century personal finance: Just about everything in our brain is hardwired against making smart decisions for our long-term security. We react to what is right in front of us, positive or negative. Extrapolating out to what we want in our life three or four decades from now, and making the tradeoffs today to reach those goals, is insanely difficult.
That’s where having a written plan can pay off big-time. This is one area where it can pay to work with a trusted financial planner to carefully walk through all the moving parts. Plenty of planners will devise a plan with you as a one-off for a set fee, if you’re not ready to sign on for an ongoing relationship. That said, if you’re suffering from multiple financial regrets, hiring a pro makes a ton of sense.
The real value of a trusted pro is to keep you committed to your plan.
Fix #3: Commit to that plan
Professor Shlomo Benartzi, the director of the Allianz Center for Behavioral Finance at UCLA, suggests you consider the Ulysses contract. Just like Ulysses was able to ignore the tempting songs of the Sirens thanks to his well-considered advance planning, you and your trusted advisor can both commit to tie your finances to the mast and thus avoid tragic temptations during periods of market volatility. At the Allianz website you can find a sample “Commitment Memorandum” — aka a Ulysses Contract.
The key points you and a trusted financial pro both sign onto:
– Hold fast to a long-term asset allocation model. We’ll review periodically, but we’re not going to allow in-the-moment emotions during volatile times to pull us off our long-term course. (That will help us steer clear of high-risk investments.)
– Embrace volatility by ignoring it. We’ll both resist the knee-jerk temptation to sell when the markets drop 25 percent or buy when the markets rise 25 percent in a short period.
– Either of us can back out, but we have to put it into writing. Deviating from the plan will only be allowed after slow and thoughtful consideration. No one-word email with “sell” in the subject line when the market is doing one of its periodic tank jobs will suffice. We commit to spelling out the rationale of how making a move today will still keep you on pace to meet your long-term goals. If that’s hard to explain, well, maybe it’s the wrong move.
It’s a good start, and hopefully will help you move on to a healthy retirement.