There are many mistakes you can make as you approach and enter retirement, some worse than others. You might pay higher fees than you need to, for example, or enter retirement with a lot of debt. But in the eyes of many people, the single greatest mistake you can make in retirement is spending too much. After all, overspending can have you outliving your nest egg, putting you in a financially precarious position late in life.
How does it happen?
Many retirees spend too much, but it happens in different ways, and for different reasons. Let's review some of them.
For starters, many people simply never give enough thought to how they will live in retirement. They don't estimate how much they need to have accumulated before they stop working, they haven't assessed their expected income streams, they don't know how much of an annual income they will need or want, and they just don't have a plan. Indeed, according to the 2015 EBRI Retirement Confidence Survey, only 48% of surveyed Americans have tried to estimate how much they'll need to save in order to have a comfortable retirement. That's a risky path.
Not having a plan can lead to your choosing to retire earlier than you should -- and that's another reason some people end up spending too much and running out of money. It's often underestimated just how powerful each year of work can be as you approach retirement. If your nest egg is $100,000 when you're 40, it might grow by 10% over the next year, adding $10,000. But by the time you're, say, 65, your nest egg might be $400,000 or $800,000 or more, and a single 10% gain would represent an additional $40,000 or $80,000. Meanwhile, continuing to work can give you more time on your employer's health insurance plan, reducing your healthcare costs, and it can result in additional employer contributions to a 401(k) plan, too.
Speaking of healthcare, underestimating how much it will cost you in retirement is dangerous. There's no way to know the exact ultimate amount, but the folks at Fidelity have estimated that a 65-year-old couple retiring now will spend roughly $220,000 on healthcare over the course of their retirement.
How to accumulate enough
You can avoid or minimize your danger of overspending in retirement by doing some thorough thinking and planning well before you retire. Perhaps start with the widely promoted 4% withdrawal rule, which suggests that you withdraw 4% of your nest egg in your first year of retirement, and then another 4% each year thereafter, adjusting the 4% for inflation. That withdrawal rate is designed to make your money last. You can use the rate to estimate the nest egg you'll need in retirement by multiplying your desired annual income stream by 25. So, for example, if you're looking for $30,000 annually to supplement your Social Security income, you'd multiply that by 25 and would get $750,000. (Four percent of $750,000 is $30,000.)
Knowing how much you need can help you know how much to sock away, ideally at least partly in tax-advantaged accounts such as IRAs and 401(k)s. Investing effectively is also important -- long-term dollars are likely to grow more briskly in stocks, so perhaps consider simple, low-cost broad-market index funds, such as the SPDR S&P 500 ETF, Vanguard Total Stock Market ETF, and Vanguard Total World Stock ETF. Respectively, they will distribute your assets across 80% of the U.S. market, the entire U.S. market, or just about all of the world's stock market. And over the very long term, the U.S. market has averaged close to 10% annually.
How to spend less
Aside from accumulating more, you can avoid the great retirement mistake of overspending by just... spending less. It's not always easy, but some strategies to consider include keeping your car longer than you planned before getting a new one, downsizing the household cars from two or more to one, moving to a less expensive house and/or region, getting a reverse mortgage, and maybe even taking in a boarder. Being strategic about when you start collecting Social Security is also smart, as there are many possibilities. Delaying when you start collecting can result in a bigger monthly check, for example.
If you want a comfortable financial future, be sure to take the time to plan it. Leaving it up to chance is setting yourself up for disappointment, or even disaster.
Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.