Let's be honest: We'd all like to get rich quick. That's why so many of us invest, after all. But while some stick to tried-and-true investments, others prefer to take a risk on unproven penny stocks. This might pay off for a lucky few, but most never manage to outperform the market.
People make similar gambles with their retirement strategy, not realizing that the consequences can be even more dangerous. Betting on the wrong penny stock might cost you your original investment, but coming up short in retirement can leave you destitute. If you want to avoid such hardship, avoid the three following mistakes.
1. Putting off retirement savings now with the intention of saving more later
Delaying retirement savings makes saving enough a lot more difficult. When retirement is decades away, more immediate goals, like buying a home or paying for a child's college education, can seem more important. But it's possible to borrow money for these other goals. There's no way to borrow for retirement if your savings come up short.
Putting off retirement savings actually costs you money in the long run. If your goal is to save $1 million by 65, and you expect a 7% average annual rate of return, you only need to save about $403 per month if you start at 25. Over your lifetime, you'd contribute about $193,440 of your own money, with the remaining $806,560 coming from investment earnings.
But if you failed to save anything for retirement until you were 30, you'd have to set aside $582 per month to reach your goal, assuming the same average annual return. That means over the course of your working years, you'd have to put $51,000 more of your own money aside for retirement than you would have if you'd started at 25.
Some people do manage to successfully save for retirement despite a late start, but the longer you wait to begin, the more likely you are to come up short. That's why you ought to start saving for retirement as soon as possible, even if you can only spare a few dollars each month.
2. Saving an arbitrary sum without calculating how much you actually need
Everyone's retirement plan is different, so there is no magic formula to tell you how much you should save. For a long time, $1 million was considered the gold standard for retirement savings, but with inflation driving up costs and people living longer, a lot of workers will need more than this to retire comfortably.
Some people may be able to live comfortably on $1 million in personal savings, especially if they have Social Security and a pension to help them. But rather than hope for the best, you should take the time to calculate how much you'll actually need.
There are a few ways you can go about this. One popular strategy is to save 25 times your annual salary. You can also try to estimate your annual retirement expenses by thinking about your goals and how your current spending habits will shift over time. Once you have a guess of how much you'll need to spend each year, multiply this by the number of years of your retirement and add 3% annually for inflation.
This can give you a baseline for how much you need, but your savings goal doesn't have to be set in stone. If your plans change over time, you can always adjust what you're regularly setting aside.
3. Planning to make up for a savings shortfall by cutting expenses in retirement
Those who are approaching retirement with a small nest egg may try to make up for their savings shortfall by planning to reduce their retirement expenses. This might work for people who had planned a lot of travel or discretionary purchases in retirement, but it's probably not going to work for those who had planned a frugal retirement from the beginning.
There are some expenses in retirement you can't control or eliminate. You're always going to need groceries, housing, and medical care, for example. Emergencies are bound to happen in retirement as well, and these can also lead to unexpected costs.
For those facing a retirement shortfall, delaying retirement is often a better strategy. This reduces the length and cost of your retirement, and it also gives you more time to save. Your existing investments will have more time to grow as well.
If delaying retirement doesn't appeal to you, you might consider working part time in retirement or starting your own business. These strategies can help you meet your financial obligations without worrying as much about unexpected costs.
Risks are a natural part of investing and retirement planning, but if you want to grow -- and keep -- your wealth, you need to avoid the high-risk strategies discussed above. Focusing on get-rich-quick schemes in lieu of slow-and-steady retirement savings is just going to lead to problems later.