8 Common Mistakes Retirees Make
Reprinted courtesy of MarketWatch.com
Published: May 15, 2013
To read the original article click here
When I talk to retirees about their money, I am often startled by the mistakes they make, and by how happy they seem to keep making them.
How many mistakes in the following list might apply to you — or maybe to your parents?
One: Most retirees don’t monitor and control their spending by having even a simple budget. For any business, that’s a recipe for trouble and pain. I think the danger is similar for any household.
Without a budget, you are much more likely to overspend than to underspend. That’s not good.
Two: Most retirees who do operate on budgets conveniently neglect to plan for predictable expenses such as income taxes and replacement of or repairs to items such as vehicles and homes. These things are a part of normal life, and there is little excuse for them to be treated as emergencies.
Three: Many retirees base their standard of living on unrealistically high return expectations from their investments, leading them to take out more money than is prudent. Whatever the reason, this is another recipe for future trouble.
Four: Another common mistake is taking out more money than a retirement portfolio is likely to support in the long run. According to one survey, about 30% of retired households are tapping into their investments at an annual rate of 7% or higher. Unless you have a very large amount of money, taking even 6% a year can put your portfolio in jeopardy of running dry.
If you take out too much, you may suddenly need to make major changes in your spending just to get by. On the other hand if you start out with a slightly more modest retirement lifestyle, you’ll have a much easier time sustaining it without the need for drastic cutbacks.
One variation of this is taking out a fixed amount every year (or even worse, a growing amount) regardless of what is happening to the value of your portfolio.
For a while, this can seem to be working just fine. But after a few years, the toll of growing withdrawals can do lasting damage to the value of a portfolio. A fixed amount that once was a relatively conservative 5% withdrawal can easily grow to 6% after a few bad years in the market. Left unchecked, this can get out of hand to the point that even a strong market recovery can’t repair the damage.
Each year my wife and I live on withdrawals that are equal to 5% of the value of our investments the prior Dec. 31. After a great market year, we get to spend a little more money. After a bum year, we tighten our belts.
Five: Too many retirees overreact to bear markets. After the huge losses of 2000-2002 and again in 2007-2009, many investors swore off equity funds altogether, wanting nothing but bond funds.
Bond funds are usually good to investors during bear markets. But we all know the perils of having too much of a good thing. For very conservative investors, even 20% in equity funds can boost after-inflation returns by 50%.
From 1970 through 2012 (43 years), the returns from a diversified all-fixed-income portfolio failed to keep up with inflation in 16 calendar years. Switching just 20% into diversified equities, however, reduced the losing years to 12 and added 1.2 percentage points to the annual after-inflation return.
Six: Some super-cautious retirees hang onto very risky investments for much too long. Often this is a large position in the stock of a former employer.
Investors who have made money in risky things can be reluctant to sell because they would have to pay capital gains tax on their profits. If their investments are worth less than they cost, these investors don’t want to make their losses “real” by selling. Either way, they are carrying too much risk.
Seven: Reaching for higher returns, many retirees give up liquidity on the word of a salesperson. This is rarely necessary, but often catastrophic. When illiquid investments such as limited partnerships go bad, the income that was supposed to support a retirement lifestyle can vanish. Second, as you would expect, the demand for such an investment can dry up quickly, sending the market price into a downward spiral. Investors often have to sell such investments for less than half what they paid.
Eight: Too many retirees compromise their futures by giving money away, either to charities or to their children, that they need to support themselves. Despite the pleas of your children, your first financial obligation must be your own support and stability.
You may be able to bail your children out of trouble. But if you get into trouble, they may not be able to bail you out. In many cases you will be doing your children more of a favor by encouraging them to find their own best solutions instead of by giving them money.
I think the best way to avoid these eight common mistakes is to buy a few hours of time from a competent professional adviser who doesn’t sell products. Whatever you pay will most likely be a good investment as you check your assumptions and look for potential challenges and solutions that you may have overlooked.
Richard Buck contributed to this article.
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