To err is human, but you can sidestep some of the most common mistakes people make in saving for retirement by avoiding these four oh-so-tempting behaviors.
Even though you know you will get older and eventually retire, a little part of you still believes you might not. Nobel Prize-winning economist Richard Thaler, the founding father of behavioral economics, has spent much of his career exploring why so many Americans have difficulty saving for retirement. One thing he found is that people would rather enjoy what their money can do for them today rather than in the future.
Being too loss averse
We don’t like to lose money, so the notion of less money in our paycheck today to serve our needs in the future is a tough pill to swallow. The problem with loss aversion is that we keep delaying that uncomfortable feeling of a smaller paycheck. If you delay too much, you lose out on the compounding effect. For example, if you decide to save $5,000 a year beginning at the age of 35, by the time you’re 65 — assuming a 4.5% rate of return — you’ll have 43% less savings than if you had started saving at age 25. That adds up to $240,000.
Not practicing discipline
When deciding how to invest, too often investors try to time the market rather than follow a disciplined investment approach. Trying to get in the market “at the right time” sounds smart, but in reality, it often leads to inaction, because that right moment never seems to come. The idea of timing the market only reinforces the first two mistakes (procrastination and being too loss averse). Here’s an example of a disciplined savings strategy: You could start by putting $5,000 away, and then add 5% each year. It might sound boring, but in the end, it will add up to much more than a “timed” strategy that never quite launches.
Tinkering with your portfolio
You want to take a more active role in your investments? That’s good, except if you have a tendency to overmanage. This often happens with retirees, who find themselves with more free time than ever before and take a keen interest in chasing performance. In the research paper “Trading is hazardous to your wealth,” authors Brad Barber and Terrance Odean found that, on average, households turned over 75% of their equity portfolios annually and underperformed by 1.5% each year. The biggest cause of this is mistiming when to buy and sell a particular fund. People often are driven by the desire to own more of that “hot” stock in rising markets when others are buying, or by “fear” in falling markets when others are selling. In a diversified portfolio, you’ll always be tempted to adjust the portfolio exposure in favor of the best-performing asset classes. The problem is, acting on that temptation may be costing you.
So, what’s the trick to saving for retirement? Actually, there is none. Start saving for retirement today and stick with it. No gimmicks, no magic timing and no schemes that will “pay off big.” Just old-fashioned discipline.
Michael Toth is senior vice president-wealth management for UBS in Grand Rapids.