In life there are many do-overs, unfortunately retirement is not one of them. There are ways we can make up for lost ground, but this can be difficult to do if we get too far behind.
That being said there is no better time than the present to make sure you are taking the necessary steps to prepare.
I want to go over three common mistakes that can either derail or hurt your progress as you prepare for retirement.
Missing out on Compound Interest
Perhaps the most powerful component when it comes to building wealth is time. The longer you have to benefit from compounding interest the better.
A common mistake individuals make is delaying their retirement investing.
Let’s consider two examples that show the power of getting started early – looking at someone who started when they were 25 opposed to someone who started at 40.
|Rate of Return||6%||6%|
|Total amount Invested||$96,000||$60,000|
|Balance at age 65||$400,300||$139,300|
As you can see the individual that started at 25 accumulated $260,000 more towards their retirement – even though they only contributed $36,000 more during those first 15years. The difference is the compounding interest we spoke about.
As you can see, time makes a big difference!
Let’s consider another example using the same two individuals. How much would the 40-year-old have to contribute each month to catch up to the 25-year-old?
|Rate of Return||6%||6%|
|Total amount Invested||$96,000||$172,500|
|Balance at age 65||$400,300||$400,300|
It is possible for the 40-year-old to catch up but it requires investing almost 3x as much monthly, $575 opposed to $200.
This example isn’t used to discourage you, but rather show you the importance of getting started as early as possible.
One of the biggest mistakes we make is waiting. Even if you haven’t started yet, don’t delay. Starting today will greatly impact your ability to grow your wealth.
Contributing too Little Towards Retirement
Another mistake that is often made is contributing too little towards your retirement. In the example above we explored how much a 25-year-old and a 40-year-old could amass with $200 per month.
The truth is that the $400,300 (25-year-old) and $139,300 (40-year-old) they will have at 65 is not enough to retire on. It is better than nothing, but will still provide for a very modest retirement.
So how can we increase the amount going towards our retirement?
Many individuals leave a great deal of money on the table by not taking full advantage of what their employers are offering.
Let’s assume your employer will match 100% of the amount you contribute toward your retirement. We will keep looking at the same $200 contribution to make things simple.
Here is an example of the impact:
|Rate of Return||6%||6%|
|Total amount you contributed||$96,000||$60,000|
|Total employer contribution||$96,000||$96,000|
|Balance at age 65||$800,600||$278,600|
By simply taking advantage of your employer match you have doubled your retirement savings – without doing any extra work other than contributing what is required to get that match.
If your employer does not offer a 401(k) consider asking them to do so or searching for a job that does offer it.
The cost of not having one established can mean hundreds of thousands of dollars at retirement. If an employer isn’t offering retirement, it is also unlikely that an individual will go out and do it on their own.
This can mean the difference between a large sum at retirement and nothing – this employer match is a very important piece.
If it is not offered you will need to make up for this lost contribution by contributing more of your own money. This is not impossible, but will likely put additional strain on your finances.
Make sure you are doing your spending reviews to see where you can save money so you can contribute appropriately to retirement.
Overall a good goal to aim for is contributing 10% of your income towards retirement. Getting your debt paid down and having an emergency savings in place is a crucial part of being able to contribute the full 10%.
Paying Excessive Management Fees
The first two common retirement mistakes were probably not much of a shock to you, but the third is one that is seldom considered.
For many years I didn’t fully understand the true impact of fees on my retirement.
When you have a 401(k) it is administered by an investment company. Essentially, they pass on fees to you for the management of these funds.
I have no problem with these investors getting paid for this management. The issue I have is that the high-priced funds seldom outperform the low-cost ones.
A high-priced fund can cost anywhere from .5% to as high as 1.5% per year. That means if the fund returns 6%, you are essentially making 4.5 to 5.5% – depending on the exact fee.
That difference in return goes to the management company.
In recent years, the cost of these funds has been declining dramatically. There are many funds inside most 401(k) plans that are now .05% per year. That is 10 to 30 times less expensive than the highest priced funds – and they often outperform or at least perform the same.
Does that have an impact on your retirement, absolutely!
Let’s take a look…
Let’s assume the same example from above with the 25 and 40-year-old and look at a 4.5% return – the amount you make after fees.
|Rate of Return||4.5%||4.5%|
|Balance at age 65||$538,500||$222,000|
Compare this to a 6% return we looked at above:
|6% Rate of Return||$800,600||$278,600|
As you can see from these two examples, having at 4.5% return – because of higher fees – has a considerable impact on your wealth.
If you are able to keep that additional 1.5% you would have lost in fees you would have between $56,600 and $262,100 in extra money when you retire.
If you are going to use a fund that has higher fees, you must look closely to make sure it has a much higher return to account for those fees you are paying – often that is not the case.
It is not my purpose to point you to an exact fund – I am not licensed to do so – I am simply pointing out the true cost of some of these managed funds.
Paying close attention to your return, and specifically how much you are paying in fees can make a significant impact at retirement.
It is important to understand how these three factors affect your retirement growth. Each of them, if ignored, can have a significant impact on your final results.
Time is powerful because it gives your money more time to grow. It also helps smooth out the impacts of recessions as you are spreading it out over a much longer period of time.
Investing too little will put you in a position of having to play catch-up later on. Try to invest 10% of your income and be sure to take advantage of your employer match as it is free money.
Fees can cut your retirement growth down by almost 25%. This will knock years off of how long your money will last. Pay close attention to how much you are being charged in each account you contribute towards.
Knowing how these three areas impact your retirement is vital. Look at your current picture and make any necessary tweaks as soon as possible.
It will have a significant impact on your retirement!
Thank you for reading.