The sooner you start saving and investing for retirement, the more money you may accumulate for your golden years. Preparing for retirement is your most important financial goal, and it must be handled with care. Here are a handful of things to keep in mind (for more, see my previous post):
Your retirement money has to be spread over 20 to 30 years. You don't need all your money on the day you retire—it has to last 20 years or more. That's why you need to establish an investment plan and stick to it. When you're young and in the accumulation stage, you have the luxury of time. If you make an investing mistake, there are things you can do to make up for it, such as change jobs or get a second job to earn more income and reduce spending. But when you retire and make a mistake, it's very difficult to replenish lost money. You need to plan ahead to ensure that your money will last for the rest of your life.
Make sure your monthly withdrawals are sustainable. How do you know how much money you can withdraw from your retirement accounts each month? This can't be a guessing game. You have to calculate it. It's important to know how long your money will last based on how much you plan to spend each month.
Inflation can cause problems over the long term. Some people stash money in ultra-safe products like certificates of deposit (CDs). The problem is that in today's environment, CDs are paying extremely low interest rates. If you put all of your money in CDs, you can be almost certain that over time you will lose purchasing power. If you can afford to live on that money today, 10 years from now it's going to cost more to buy the same things because of inflation.
Avoid having to sell investments when prices are lower. Because of longer life spans and inflation, you have to own growth investments to keep up with the rising cost of living each year. While you build wealth in your working years through growth investments, you should change your investing strategy to be more conservative as you get closer to retirement. If you don't plan correctly and the market declines for a while, you might not have enough money to pay for living expenses in retirement years, which could force you to sell holdings when prices are down.
To avoid this common mistake, hold a combination of growth investments to stay ahead of inflation, and bonds or CDs to generate some of income for your monthly or recurring expenses. This helps ensure that you don't have to sell growth investments if they have recently declined in value. Spreading your money across investments with different maturities can protect you against short-term swings in the market and provide certainty of income on a monthly basis. Meanwhile, growth investments such as stock funds typically generate higher returns and help you beat inflation.
Beware of investments that tie you up. Annuities and other products that have surrender fees over a long time period are usually not a good idea. Some annuities have a seven-year surrender period, which means you'll pay a penalty if you sell the investment before holding it for at least seven years. At first, you might think that seven years is an acceptable amount of time because you're a long-term investor. However, seven years is a long time.
My daughter is 20 years old, and she thinks she knows everything there is to know about the world. I did too when I was that age. Then, when I was 27, I remembered how foolish I was at age 20.
Ask yourself: Is your outlook about investing different now than it was seven years ago? Is your view about life different from what it was 14 years ago? Our outlook on life, insights about ourselves, as well as our goals and aspirations change over time. When you own an investment that comes with a penalty for selling it in a certain time frame, you'll end up keeping something you would otherwise sell because you don't want to pay the penalty. You should never want to own an investment based on anything other than whether it's meeting your goals and aspirations.
Adam Bold is the founder of The Mutual Fund Store, which provides fee-only investment advice with locations coast-to-coast. He's also host of The Mutual Fund Show, a call-in radio program broadcast across the country. Bold is author of the book The Bold Truth about Investing (April 2009). Bold is Chief Investment Officer of The Mutual Fund Research Center, an SEC-registered investment adviser, which provides mutual fund and asset allocation recommendations, and research to stores in The Mutual Fund Store system.