Retirement, retirement, retirement — I'm sure it sometimes feels as though we in the financial planning profession don't know how to talk about anything else. Personally, I'd bet that half to two-thirds of what I talk and write about professionally is somehow connected to the topic. So what's the big deal? Does retirement planning really warrant this much airtime?
In a word — YES!
Why? Because the good old days of companies providing lifetime pensions are long gone for many of us. Instead, we now live in a world where most people have to shoulder the burden of their retirement success pretty much on their own through 401(k)s, 403(b)s and other defined contribution plans. Consequently, we need to make sure we are using them well.
To help in that regard, I'd like to dedicate a little time today to discussing four big retirement plan mistakes and how to avoid them.
Mistake No. 1: Not participating because there is no match
People often think, "My employer doesn't match my contributions, so I'll save on my own instead. That way, I get more investment choices." Unfortunately, this good theory often breaks down at the point of implementation. To make it work, you actually have to save the money — and left on their own — many (if not most) people won't.One of the great features of company retirement plans is that once contributions are established, there is virtually no work required on the part of the participant to save. The savings happens before you ever get the money — it just doesn't get much easier than that!
So don't give up on an employer-provided plan just because there isn't a match.
Mistake No. 2: Borrowing from yourself
For someone finding themselves in a financial rut, taking a loan from a retirement plan can look like a sensible strategy to get back on track. After all, you'll be paying yourself the interest instead of paying a bank, right? Well, there are at least three problems with this logic. First, you remove the growth potential from the borrowed money. Second, if you lose your job and can't repay the funds (which would probably be difficult since you just lost your job), the loan will be treated as a distribution and subject to taxes and possible penalties. Third, borrowing from a retirement plan eliminates the sanctity of your retirement funds.
These funds should be cherished and protected since they are your ticket to ride the freedom-from-work train some day. Once you tap them for other reasons, it becomes much easier to do it again and before you know it, you'll want to retire some day but won't have the money to do it.
So, before turning to your retirement plan to fix a bad situation, be sure to exhaust all other options first. Your ability to quit working likely depends on these funds, and you can't use them in retirement if you took them out 10 or 20 years before.
Mistake No. 3: Cashing out to catch up
Similar to Mistake No. 2, it's often tempting to cash out old retirement plans to pay off debts and wipe the slate clean. Many taking this path argue that the 10% penalty for premature distributions isn't as painful as some credit card interest rates. There are at least two problems with this approach. First, it could cause significant damage to your ability to retire some day, since not only will the cashed-out funds not be available, but the future growth, and growth on that growth (think compounding), won't be either. The second major problem with this approach is that it often doesn't fix anything. Unless the behaviors and circumstances that resulted in the debt in the first place are addressed and corrected, the debt will eventually come back. Unfortunately, the forgone retirement savings won't.
So, like my advice for Mistake No. 2 (but perhaps even more strongly stated), be sure to exhaust all other options first before prematurely cashing out a retirement plan.
Mistake No. 4: Playing amateur market analyst
In an attempt to "make it big" or "keep my powder dry," many retirement plan participants mistakenly think they can pick the right times to get in and out of certain asset classes. Highly educated, professional money managers who earn huge salaries for their expertise in this area often have a difficult time doing this. Consequently, it's not hard to understand why it is so difficult for the average investor to successfully time the market.
So, rather than try to time the market to win the race to retirement, I suggest building a diversified portfolio or using funds that do it for you. If you remember the story from your childhood, it was the tortoise that won the race, not the hare. While the tortoise metaphor is probably taking it too far, something less than the hare is probably more appropriate for most people.
The good news is you're not alone in your pursuit of retirement savings happiness — as I mentioned earlier, there's now an awful lot of us in the fund-your-own-retirement boat. And as a result, there are a lot of resources and information available to assist you.