If you’re consistently saving at least 10 percent of your income for the day when you leave the workforce, you’ve taken an important first step towards ensuring a comfortable retirement. Still, saving only gets you so far. The next step—investing that money—will help ensure your savings grow enough to support you when you’re no longer employed. To get you on the right track, here are four investment mistakes to avoid.
1. Focusing on Low Risk Investments
Too many investors keep their money in low risk investments, often because they’re uncomfortable making “harder” investment decisions or they want to avoid the inevitable stock market dips. While that CD feels safe (because it is), the 0.01 percent you’re earning on it isn’t going to help you grow your nest egg. In fact, keeping your money in such low-earning investments can actually make you lose money because of inflation.
Investments that offer higher returns always come with more risk, and you have to be willing to accept some risk if you want to grow your money and retire comfortably. To compensate for today’s longer life spans and inadequate retirement savings, many financial planners recommend subtracting your age from 110 (or even 120) to determine the percentage of your portfolio that should be in higher-risk investments like stocks as opposed to more conservative investments like CDs and bonds. With an average return of about 7 percent per year, stocks are one of the best ways to boost your retirement savings.
2. Putting All Your Eggs in One Basket
While it may be easy to put all your investment dollars into one stock, it’s a risky move (e.g., if that stock tanks, so does your entire portfolio). One of the best ways to manage risk is to diversify your investments. A diverse portfolio mixes a variety of investments—a combination of stocks, bonds, and cash savings—to balance riskier investments with safer ones. This strategy limits your overall risk while still giving your money a chance to grow.
In general, a portfolio constructed of a variety of investments will yield higher returns and pose less risk than any single investment within the portfolio. To build a diversified portfolio, look for assets that typically move in opposite directions, and try to diversify within each type of investment. You can diversify stocks, for example, by market capitalization, sectors and geography, as well as by style—such as growth and value. With bonds, consider varying maturities, credit qualities and durations.
3. Not Opening an IRA or 401(k)
If you put all your retirement savings into a regular brokerage account, you’ll miss out on valuable tax advantages that come with IRAs and other retirement accounts, such as 401(k)s. Tax-deferred retirement savings accounts, such as Traditional IRAs and 401(k)s, provide a tax break when you put money in. Contributions to Traditional 401(k)s are made with pre-tax dollars, and you can deduct your contributions to an IRA when you file your annual return. You’ll pay taxes on the money you withdraw during retirement.
Roth IRAs and Roth 401(k)s work the opposite way. You pay taxes upfront when you contribute to these accounts, and receive the tax break when you withdraw money tax free during retirement. With either type of IRA or 401(k), you won’t pay capital gains taxes on any sales made within the account. Of course, the sooner you start contributing to these tax-advantaged retirement savings accounts, the better, since you’ll also be able to take advantage of the power of compounding.
4. Not Making a Plan
If your idea of a retirement plan is to never retire at all, it’s time for a new plan. Even if you think you’ll keep working forever, you could be forced into a retirement you never intended to take if you get sick or lose your job—or if you have to leave the workforce to take care of a loved one.
If you’re already saving at least 10 percent of your income, put that money to work by making an investment plan based on your specific goals, time horizon and risk tolerance (and if you’re not saving yet, get started!). Work on creating a diversified portfolio that limits your risk while still allowing your money to grow. Maximize your contributions to retirement savings accounts like IRAs and 401(k)s to take full advantage of the power of compounding. And ask for help if you need it—paying for a meeting or two with a financial advisor can be well worth the investment.