Saving and investing for retirement isn't always a clear-cut process, but it could be simpler than some people make it out to be. There isn't a single strategy that universally works for everyone, but there are ways to be more efficient in your retirement savings, mainly by avoiding common mistakes.
Here are three mistakes you'll want to make sure you avoid making.
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1. Relying on high-cost target-date funds
There are many great benefits to a 401(k), but unfortunately, the investment options aren't one of them. In a 401(k), your plan provider provides you with investment options. Most plans include your company's stock (if it's a public company), funds grouped by market cap, an international fund, and target-date funds.
Target-date funds are funds put together based on your projected retirement year. As you get closer to retirement, the fund automatically reallocates its holdings to become more conservative (more bonds and cash, fewer stocks). On the surface, this hands-off approach seems ideal, but when you look at the cost of this convenience, it's often not worth it over time.
Since target-date funds are actively managed, they tend to be more expensive than index funds -- in some cases, egregiously so. For perspective, the average target-date fund fee was 0.32% in 2022, according to Morningstar. For perspective, the Vanguard S&P 500 (VOO 0.27%) has an expensive ratio of 0.03%.
This isn't quite an apples-to-apples comparison because a target-date fund contains many funds, but it shows how much cheaper other options are. Instead of relying on a target-date fund, you could essentially invest in the funds held within the target-date fund and reallocate your own portfolio.
As an example, let's assume two people invest $1,000 monthly and average 8% annual returns over 25 years. Here's roughly how their investments would look based on fees paid over that time:
| Expense Ratio | Fees Paid | Investment Value |
|---|---|---|
| 0.32% | $39,900 | $837,300 |
| 0.03% | $3,800 | $873,400 |
Data source: Author calculations / Rounded to the nearest hundred
Even the slightest differences in fees can add up to tangible amounts over a career.
2. Not using an IRA
A 401(k) is the most common type of retirement account, but it's not the only option. IRAs are also great options with many benefits you won't receive with a 401(k).
There are two main types of IRAs: Roth and traditional. Contributions to a Roth IRA are made after tax, and you get to take tax-free withdrawals in retirement. A traditional IRA works similarly to a 401(k) because your contributions may be tax-deductible.
Tax benefits aside, IRAs are great because they give you more freedom than a 401(k). You can invest in any individual stock or exchange-traded fund (ETF) you want, allowing you to tailor your investments to better fit your financial goals and risk tolerance.
Whether you go with a Roth or traditional IRA often comes down to your current versus projected tax bracket. If your tax bracket in retirement will be higher than your current one, consider going with a Roth IRA so that you can pay taxes now at a lower rate. If your tax bracket will likely be lower in retirement, consider a traditional IRA to delay taxes until you're in the lower bracket.
IRAs have a relatively low annual contribution limit -- $6,500 ($7,500 if you're 50 or older) -- so they're best used as supplemental retirement income instead of the primary source.
3. Overestimating how much you'll receive in Social Security
Since Social Security is a large part of many people's retirement income, it's important not to overestimate how much you'll receive because it could leave an income-expense gap you weren't expecting.
For 2023, the maximum monthly benefit for people claiming benefits at their full retirement age is $3,627. If you claim early at age 62, the maximum is $2,572; if you decide to wait until age 70, the maximum increases to $4,555. Unfortunately, most people don't come close to receiving the maximum monthly payout.
Social Security calculates your monthly benefit by taking a percentage of your average income during the 35 years when your income was highest (adjusted for inflation). To receive the maximum payout, you must earn at least the inflation-adjusted wage base limit for 35 years, which isn't an easy feat. The wage base limit -- an annual limit on how much of your income is taxed and used in Social Security calculations -- is $160,200 for 2023.
The average monthly benefit for retired workers as of April 2023 was $1,834, almost half the maximum payout for people claiming benefits at their full retirement age. To get an idea of how much you can expect from Social Security, check your earnings record on the Social Security website.
