Retirement -- it might seem far away now, but the quality of your retirement is being determined every day of your life, no matter how young you are. In fact, the earlier you start thinking about retirement, the better, thanks to the magical effect of compound interest. Yet unfortunately, several very common habits can prevent people from reaching their retirement goals.
There's no shame in admitting that you have some bad financial habits. In fact, most people have committed one of the following five sins at one time or another. However, the sooner you recognize a problem behavior and fix it, the better your retirement situation will look.
Here are five common behaviors that can impede your future retirement health.
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1. Not saving
First things first -- retirement benefits accrue from investments, which come from your savings, and it's impossible to save if you don't spend less than your income. If you find you're spending too much relative to your salary, take a hard look at your spending. That includes making a budget and getting an overview of your expenses. Big ticket items often include housing, transportation, and food.
If you're in an apartment or house that costs too much, take a hard look at moving. Moving can be disruptive to your life, of course, and requires a large one-time expense, but ongoing monthly savings in the hundreds or even thousands can make a big dent in your spending and give your retirement savings a jump-start.
Another major expense can be your car. Between car payments, fuel, maintenance, and insurance, this is a large monthly expense. If you live in a dense city or are in a two-car household with your significant other, consider selling one car and using public transportation or a ride-sharing service. You may be surprised by how much you can save if you forego this convenience.
A final expense is food. Eating out obviously costs more, and depending on where you live, it could be much more. To save money, make a habit of cooking at home. In addition, most major grocery chains today have high-quality ready-to-eat meals and meal kits. You may be surprised how much you can save.
If you're young, all the more reason to begin saving, even if it's a modest amount. Thanks to the miracle of compound interest, saving early and investing in your portfolio or 401(k) plan can lead to bigger gains the longer you're invested. Those who start investing later in life have an exponentially tougher time catching up.
2. Taking on credit card debt
Even worse than having no savings is taking on a significant amount of credit card debt. While many people use credit cards to cover large purchases, it's never a good idea to get too big of a revolving balance.
That's because credit card interest rates are extraordinarily high; the average APR for new credit card applicants right now is more than 19%. For comparison, the average annual return of the S&P 500 since 1957 (when the 500-stock index came into being) is only about 8%.
Think you're a superstar investor and can beat that nearly 20% APR? Maybe... if you're Warren Buffett. The greatest investor of all time has grown his company, Berkshire Hathaway, by a compound 20.5% rate between 1965 and 2018. So even if you managed to find the best long-term stock in the world, you might only be able to beat the average credit card APR by a point or two. Good luck with that!
The bottom line: Pay off your credit cards ASAP.
3. Taking too much risk
Once you have some savings left over to invest, another bad habit is to take on too much risk. While many say you're free to take on riskier investments if you're younger (since you have a lifetime to earn the money back), remember the above advice regarding compound interest. The sooner you invest, the better. Therefore, losing all of your investable dollars early on will delay your retirement compounding machine. And if you are not exactly young anymore, the risk of permanent loss in the hopes of "hitting it big" can be an even larger and more severe setback.
Excessive risk-taking in the hopes of hitting investing "home runs" can come in several forms, including using too much leverage via margin loans, investing in things in which you have no knowledge, investing in illiquid or volatile securities, and speculating on price movements instead of valuing assets.
The recent cryptocurrency mania is an example of a few of these risks all rolled into one. Though some early buyers of bitcoin (BTC-USD) made lots of money, those who bought into bitcoin and other crypto-currencies later on once they became a "hot" investment topic quickly saw their money evaporate as bitcoin fell from about $20,000 in 2017 to below $3,200 earlier this year. Though bitcoin has bounced back above $9,000, how many -- especially those who don't really understand the asset, or those who invested a disproportionately high amount -- held through the nearly-90% loss?
Now, I'm not against bitcoin per se -- the same could be said about tech stocks in the late 90s or the Dutch tulip craze of the mid-1600s. In fact, I own a small position in bitcoin tokens. However, savers should understand what sound investing means -- that is, buying into high-quality stocks or bonds -- and what is speculation. My bitcoin position is an extremely small piece of my overall portfolio, and I'm prepared to see that small piece lose all of its value. By contrast, those who put too much of their wealth into volatile and speculative assets are at a very high risk of losing a large part of their retirement savings, an unnecessary risk for those with a patient, long-term focus.
4. Not taking enough risk
Though many investors bet on assets that are too risky for them, many also commit the opposite sin -- not taking enough risk. This could include not investing in stocks early on in your adult life, or even worse, not investing at all and keeping your savings in cash for fear of a market downturn.
The value of your cash diminishes over time due to inflation. While we are currently in a very prolonged period of low inflation, your money will still, on average, lose about 1% to 2% of its value every year, and even more if inflation ticks up to historical levels. Therefore, just to preserve the value of your savings, you need to earn an after-tax return above 2%.
If you want to invest, but are scared of violent market sell-offs such as the one in 2008 or even the volatility of December 2018, remember this: It's never a bad idea to invest in a diversified basket of quality stocks or an index fund if your time horizon is long enough. Therefore, don't worry about timing the market. Making consistent investments in regular monthly or quarterly intervals is likely your best bet.
The key is having a plan and not letting the fear of a correction or the greed of a hot market sway you; that can lead to the next bad habit.
5. Excessive trading
A final bad habit is excessive trading. The dangers of excessive trading are several. The first and most obvious is the cost of trade commissions at your broker. Although there are a number of very low-cost online brokers, trading a lot can still dent your long-term returns.
The second and arguably more sinister effect of excessive trading is the age-old emotional cocktail of greed and fear, which can lead you to buy or sell at the wrong time, denting long-term performance. J.P. Morgan Asset Management found that if you missed out on just 10 of the market's best trading days during the 20 year period between 1995 and 2014, you would have seen your overall returns more than cut in half. Another amazing fact? The average mutual fund investor performs worse than the average mutual fund. How? Investors tend to flock to top-performers after great runs, and abandon underperformers after a period of lagging returns.
By making sure you save money every month, avoid credit card debt, invest regularly in high-quality stocks and/or bonds, and avoid excessive trading, you'd be surprised at how much healthier your retirement picture will be.
