Plenty of obstacles stand between you and your early retirement goals. Fortunately, a number of the most common mistakes are well-studied and relatively simple to avoid. Steer clear of these silly missteps to accelerate your financial plan toward financial freedom and an early retirement.
1. Saving too little
Asset accumulation is among the first and most important steps in retirement planning, but too many people try to skip it. If you don't save your income, then there's nothing to invest. That might sound oversimplified, but most Americans don't handle this step appropriately. There's basically no shot at retiring early without being an excellent saver.
Every household has different circumstances, but most experts recommend saving anywhere from 10% to 20% of annual income. These numbers aren't chosen arbitrarily -- those are the average amounts that need to be set aside to maintain lifestyle throughout retirement.
Financial planners consider the 4% Rule to figure out how much retirees will need to generate a certain amount of income, which allows them to calculate the required savings relative to household income. Personal savings rates in the U.S. have generally hovered between 5% and 10% over the past decade, so the deficiency is quantifiably large. People need to save more.
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Luckily, there are well-established strategies to boost household savings rate. Most households can benefit from bringing organization to their cash flow planning, and setting clear goals for asset building. It can be very beneficial to calculate the amount of each paycheck and develop an attainable budget. It's not realistic to expect every month to go smoothly -- there will definitely be times when it's impossible to meet your savings goals for one reason or another. Nonetheless, it's important to set measurable goals and track progress.
Organization and clarity are important for meeting your retirement goals. If you commit to a good savings rate and consistently live by a budget, you can take a big step toward retiring ahead of schedule.
2. Misallocating your portfolio
Once you've built assets to invest, it's important to get the portfolio allocation correct.
Investment time horizon is probably the most important consideration when it comes to retirement account allocation. Historically, stock market returns have outpaced bond returns over the long term. The S&P 500 has never lost value over any 15-year window. However, the stock market goes through cycles that typically last five to 10 years, and equities can quickly shed value in the short term.
That's why the time horizon is so important. People in their 30s and 40s generally have plenty of time to ride out one or two market cycles. Funds in your 401(k) or IRA aren't intended to be accessed until age 59 1/2, so younger investors shouldn't be locking in any short-term losses during market downturns. There's plenty of time for the retirement account to recover and grow, as we've seen time after time throughout history.
These people should prioritize growth, meaning that their retirement accounts should be heavily weighted toward equities and growth stocks, with lower allocation to bonds and dividend stocks. You can accelerate your retirement plan with an aggressive allocation, but being too conservative in the early years can delay the whole process.
The opposite is true for people approaching retirement. An unexpected bear market can wipe out a huge portion of savings that were built diligently over the course of decades. If you have to access those funds within the next 10 to 15 years, there might not be enough time to recover, forcing you to lock in losses.
People who are getting into their late 40s should start shifting to a more conservative allocation, adding more bonds, dividend stocks, and value stocks to their retirement funds. These assets are less volatile, so they'll protect gains and won't drop as much during a market downturn. Greed can destroy a retirement plan. Recognize that the hard work has been done, and lock in some of the returns harvested over the years instead of taking big risks to squeeze out every last potential gain.
Consider some established guidelines to determine the right balance of securities in your portfolio based on your retirement date.
3. Trying to time the market
Once you've established the right allocation strategy, you have to stand by it. It's completely natural for investors to experience greed and fear over the course of market cycles as account values surge and retreat. There's a serious temptation to sell stocks and reduce risk during downturns. It's common to fear missing out when everyone piles on an overheated bull market.
Unfortunately, emotional decision-making can completely sabotage an otherwise diligent retirement plan. There's extensive evidence that timing the market usually backfires. Even teams of full-time professionals with sophisticated tools struggle to consistently outperform major indexes. People chasing market trends are likely reacting to news that's already been digested by the "smart money" investors. That mistake often results in buying high and selling low.
Instead of timing the market, come up with a high-conviction allocation strategy that properly reflects your goals, risk tolerance, and time horizon. It's OK to make minor adjustments to rebalance as conditions evolve, but those should never be sweeping changes to create an imbalanced portfolio. Accept ahead of time that capital market cycles are inevitable, and embrace the time-tested strategies to manage your retirement account.
This approach should simplify your financial plan, and it can avoid common mistakes that could add unwanted years to your working life.
