| People make all types ofmistakes with their money, but few are more painful than those thatinvolve the nest egg. One or two financial missteps with your retirementsavings, and you could pay a penalty well into later life.
Untilearly last year, of course, a remedy for such mistakes was close athand. A healthy stock market -- in the 18th year of a bull run, bysome measures -- covered a multitude of sins. Need to borrow $20,000from your 401(k)? No problem. By the end of the year, the marketsprobably gave you back that much and more.
Eighteen months later, the landscape has changed considerably.
With that in mind, we decided to canvass financial planners andeducators across the country and ask this single question: What arethe biggest mistakes investors today are making with their nest eggs,both before and after they retire?
From their answers, we've culled what might be called the whoppers-- the 10 errors that were mentioned most frequently and that causethe most damage.
1. Failing to consider long-term care needs.
When people think about threats to their retirement savings, "theyprimarily think about market losses," says Joe Bowie, chief executiveofficer of Retirement Investment Advisors Inc. in Oklahoma City. Whatthey fail to consider, he explains, are "the nonmarket-related threats-- health care, long-term care -- the catastrophic events" that cancause as much harm, or more, as a volatile market.
First, the good news: Most of us will never end up in a nursinghome. Now the bad news: More than 50% of Americans will need someform of long-term care, either home care or institutional care, atsome point in their lives, according to the Health Insurance Associationof America. And the daily cost of good home care already approachesthat of a nursing home: about $128 for the former vs. $157 for thelatter, according to Phyllis Shelton, an insurance consultant in Nashville,Tenn., and author of a book on long-term care.
So, the question you have to ask yourself is simple: Could youfinance potential costs of long-term care out of your nest egg? Andthe key word is "your." No one else will pick up the tab. Medicareand private insurance don't pay for most long-term care. And forgetabout transferring your assets to your kids so that Medicaid willstep in. Impoverish yourself and you "simply don't have as many choicesas a private-pay patient," Ms. Shelton says.
Yes, premiums for long-term care insurance can be steep. The averageannual tab is $1,700. But "the notion of spending a few thousand dollarsa year vs. hundreds of thousands of dollars in the future is smartmoney management," says Michael K. Stein, a certified financial plannerin Boulder, Colo., and author of a book on retirement finances.
2. Failing to consider the effects of inflationand taxes.
When is a $1 million nest egg not a $1 million nest egg? When it'staxed.
"Your nest egg is smaller than you think," says Tom Grzymala, acertified financial planner in Alexandria, Va. "One million dollarsin a 401(k) is really more like $750,000. That's because people failto discount the 25% to 30% that taxes might be costing them."
And don't assume that taxes go down when you retire. Some olderadults, when Social Security, pensions, 401(k)s and other savingsare factored in, find themselves in the same or nearly the same taxbracket as when they were employed.
Of course, if you don't pay your taxes, the Internal Revenue Servicewill drop you a friendly reminder. Inflation isn't nearly as accommodating;it robs you of your purchasing power slowly and quietly. Consider:A $1 million nest egg, with an annual rate of inflation of 3%, willhave a value of only $737,000 after 10 years.
"Volatility isn't the greatest risk to your portfolio," says WilliamHoward, a certified financial planner in Memphis, Tenn. "Inflationis. People don't understand that."
3. Failing to take advantage of the years immediatelybefore retirement.
Yes, you started saving late for retirement. And no, you haven'tsaved enough. But that doesn't mean an all-out effort in the yearsleading up to your final day at the office can't make a big differencein the size of your nest egg. That said, many investors fail to takeadvantage of the opportunity.
"We've seen people build up almost one-third of their savings inthe last five years [before retiring] because they got really seriousabout saving and investing," says Nancy Blunck, a certified financialplanner in Anchorage, Alaska. More typically, though, says Mr. Steinin Colorado, couples in their late 50s and early 60s are indulgingthemselves, given that the kids have left home. "Their lifestyle creepsup," he says. "Instead of buying the Buick, they buy the Lexus; insteadof the small SUV, they get the big SUV."
Investors also wait too long to diversify their holdings. "They'refully invested in stocks to the day they retire," says John Schneider,president of Bill Few Associates, a financial planning firm in Pittsburgh."Then they begin to scramble and diversify as quickly as possible."That process, instead, should take place gradually in the years leadingto retirement -- to avoid sudden or prolonged downturns in the market.
4. Making large loans to family and friends.
You finally made it. You're retired and sitting on a comfortablenest egg. And then come the knocks on your door.
"Your son asks you for $100,000 to start a business," says JudithA. Shine, who heads her own investment advisory firm in Englewood,Colo. "And you say, 'Sure, I'll lend you the money.' And then yourother son says, 'Well, can you lend me $100,000 to buy a house?' Andyou help him, too.
"And you never see any of that money again."
It's certainly not a case of theft or neglect. Rather, loans tofamily members, friends and former business associates seem to havea way of becoming gifts. In some cases, says Bob Confessore, a certifiedfinancial planner in Little Silver, N.J., a first request for helpto "start" a business leads to "additional requests to 'keep the ballrolling' or 'build market share.'" The result: a bottomless pit.
The appeals are made, of course, with the knowledge that you suddenlyhave considerable assets at your disposal -- which is precisely theproblem. Big withdrawals from your nest egg early in your retirementcan crimp your spending in later years.
"Many times, you're not in a position to be as generous as youwould like," says Diane MacPhee, a certified financial planner inGlen Rock, N.J. Her suggestion: smaller loans with a formal repaymentplan. She cites the example of a retired client whose daughter wasburied under $42,000 in credit-card bills. The client lent the daughter$20,000, which allowed her to refinance the balance of her debt. Meanwhile,the daughter agreed to pay back the money at 8% interest in monthlyinstallments over four years. Says Ms. MacPhee: "She never misseda payment."
5. Overestimating how much you can withdraw fromyour nest egg.
The thinking appears to be sound: "Usually, people say, 'Well,if I earn an average of 8% on my investments, then I can withdraw8%, right?'" says Ross Levin, a certified financial planner in Minneapolis.The answer is: You can -- but you shouldn't.
For starters, annual returns are seldom "average." "That 8% doesn'tcome year after year," Mr. Levin notes. Case in point: The widelywatched Standard & Poor's 500-stock index last year sank 9.1%, includingdividends. Big withdrawals from your nest egg in the teeth of a bearmarket, especially for people early in their retirement, could meanthat your money runs out before you do.
What is a realistic withdrawal rate? Most financial advisers arecomfortable with 3% to 5% (although "even 5% is pushing the envelope,"Mr. Levin says.) William P. Bengen, a personal financial adviser inEl Cajon, Calif., who has done pioneering research in this area, notesthat a "withdrawal rate of about 4%, adjusted each year for inflation,should keep you going for about 30 years, no matter what happens inthe markets." (This assumes a portfolio with a healthy dose of stocks,about 60% to 70%.)
One note: Some advisers say withdrawal rates of as much as 7% or8% may be acceptable in the early years of retirement, when you'remost active -- as long as you're prepared to reduce expenses in laterlife. "I wouldn't want to miss the opportunity for a wonderful retirement,"says Mr. Stein in Colorado. "If my [financial] plans don't work out,then I'll pull back to a 'subsistence mode.' "
6. Overmanaging a retirement portfolio.
Quick: Name two calamities that befell retirement savings plansin recent years. The downturn in the stock market? Any and all taxbills that came out of Washington? Not even close, says David Foster,an accountant and certified financial planner in Cincinnati.
"Daily pricing and Web access are two of the worst things thatever happened to 401(k)s," he says.
Mr. Foster is exaggerating, but not much. "Too many people todayovermanage their 401(k)s," he says. "At the end of the day, they seethat their growth fund lost 20%, but their value fund was up 5%, sothey get on the 800 number and start moving money."
The market turmoil of the past 18 months has only made the situationworse, financial advisers say. Many investors, after all, have neverbeen through a down market, or at least one in which they had (orstarted with) a sizable nest egg. "It's a case of not understandingunderperformance," says Ms. Shine in Colorado. "You think that youcan outrun it or trade out of it, but you can't."
The dangers of such attempts are well-documented. According toIbbotson Associates Inc., the Chicago-based investment advisory firm,a person who invested $1 in an S&P 500 index fund at the end of 1980and kept that money invested through the end of 2000 would have endedup with $18.41. But missing the 15 best trading months in those same20 years would have left that investor with just $4.73.
Says Mr. Howard in Tennessee, "If you're looking at your accountbalance each day, that's putting more stress on yourself than youneed to."
7. Taking too much risk with investments.
The traditional problem with retirement savings has been the avoidanceof risk -- keeping too much money in fixed-income investments (likebonds, for their presumed safety) and not enough in the stock market.The latter, of course, is what gives your nest egg the best chanceto grow (or at least stay ahead of inflation).
While that mistake still hampers some people, the more common problemtoday, financial advisers say, is the aggressive investor, the onewith a "casino mentality," says Mr. Bengen in California.
Such investors chase the "hot" fund or stock, or fail to diversifytheir holdings. Some do it because they haven't saved enough moneyfor retirement and now are trying to catch up; others have watchedtheir nest eggs shrink and hope to recoup their losses. In almostevery case, though, the person is putting the cart before the horse.
"You ask a client, 'What are your goals? What would make you happy?'"says Ms. Blunck in Alaska. "And they say, 'I want to beat the market'or 'I want a return of 17%.' [But] those really aren't goals. Educatingyour grandchildren, or contributing a certain amount of money [toa charity], or having a worry-free retirement without running outof money, those are goals. And you might not need [a] 17% [return]or to beat the market to achieve them. You might not have to takethat much risk.
"You need enough," Ms. Blunck adds. "You don't need more and more."
8. Underestimating life expectancy.
Eileen Sharkey, a certified financial planner in Denver, likesto tell the story about clients who inform her that they plan to buya new car before they retire, indicating that that vehicle will probablysee them through their final years.
"One car?" she says. "There's a good chance they'll live long enoughto buy five new cars."
As much coverage as the idea of increased life expectancy has receivedin the media in recent years, many investors still underestimate,often seriously, just how long they might live. Failing to do so canplay havoc with your retirement planning and finances.
"They get it intellectually," says Ms. Sharkey, referring to herclients. "They'll tell you about their aunt who is 90, or their parentswho are in their 80s. But the implications of longevity haven't becomean integral part of their thinking."
The biggest implication, of course, is the possibility that yourmoney could run out before you do. It's easier than you think. Combineseveral rough years in the stock market (particularly early in yourretirement) along with an aggressive rate of withdrawal, and the nestegg you spent 30 years building could be gone in half that time. That'swhy most planners now "use an age of 90 or 95 when developing savingsplans," says Charlie Haines, who heads his own family advisory firmin Birmingham, Ala. "And even those numbers might be too young."
9. Underestimating expenses in retirement.
You may have heard the conventional wisdom: Retirees need about70% of their annual preretirement income to maintain a similar lifestyle.Hogwash, says Ron Kelemen, a certified financial planner in Salem,Ore. "There's no bigger myth out there."
Almost without exception, every financial adviser we spoke withsaid their clients find themselves spending just as much money inretirement as they did when they were working full time. "I have yetto see a client who, the day they retired, started living on 30% lessthan the day before," Mr. Kelemen says. New retirees, in particular,he adds, "are healthy, they travel more, they're fixing up the house.Maybe their spending slows in later years -- but not at first."
Two points. First, if you're approaching retirement and are stillusing the 70% rule, you might want to re-examine whether you're savingenough, how big your nest egg needs to be and how long you need towork. This assumes, of course, that you've actually made a stab atcalculating a budget in retirement. "Lots of people don't know howmuch money it costs them to live on now," says Mr. Grzymala in Virginia."If you don't have a handle on current cash flow and expenses, youcan't get started on retirement planning."
Second, people already in retirement who find themselves spendingmore than they originally planned need to be aware of the risks ofso-called double-dipping: an excessive rate of withdrawal from savingsat a time when markets are falling. Says David Morganstern, a certifiedfinancial planner in Portland, Ore., "If you spend your retirementsavings too quickly, going back to work at 70 is a tough pill to swallow."
10. Focusing on your nest egg to the exclusionof all else.
Who makes the best transition to retirement? Teachers, says Ms.Sharkey in Denver.
Each year, during their summer break, "teachers spend two to threemonths learning to have a life," Ms. Sharkey explains. "They practicenot being at work. And that's one way to look at retirement: 30 yearsof not being at work."
The lesson here is that while tending your nest egg is critical,people who focus only on finances neglect the most important partof later life: how they're going to spend their time.
"People really don't prepare to retire," says Richard Lee, whoheads a financial advisory firm in Dallas. "They invest money fairlyconsistently along the way... but they don't prepare their lives fora smooth and fulfilling transition. It's particularly difficult formen. The relationships they've built up are, in large part, businessrelationships. But once you retire, the lunches, the outings -- theydon't happen anymore."
Thus, the question: How will you fill your days? Vague answershere -- "some travel, some work, some play" -- can be just as debilitatingin the long run as vague financial goals. "Identify the things thatyou like to do and that work gets in the way of," Ms. Sharkey says.Ideally, with some of those answers in hand, the actual transitioninto retirement itself, she says, "becomes a fairly insignificantFriday afternoon."
--Mr. Ruffenach is a reporter and editor at The Wall StreetJournal and the editor of Encore.
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