Planning for a better retirement through stock investments is a great idea. However, to do it successfully requires navigating a few common pitfalls. There are plenty of mistakes you need to avoid throughout your 30s, 40s, 50s, and even in your 60’s.
This article will look at the most common investment retirement mistakes people make and show you how to avoid them.
#1. Home Country Bias
The makeup of your portfolio is essential. But it would help if you weighed it towards specific types of stocks to make its payout. The U.S. stock market has been particularly fruitful over the last few years.
According to research from the investment giant Vanguard, 81% of their investor’s portfolios are U.S. stocks. However, according to other research from MSCI, the stock market financial data providers, the U.S. MSCI market has beaten the ex-U.S. MSCI market by about 52% over the last few decades.
This home-country bias suggests a mix of around 50/50 home and foreign stocks would be optimal.
#2. Sequence of Returns Risk
Many people plan to use the money they’ve invested in the market as a source of income for retirement. However, far too many of these people are unaware of the sequence of returns risk.
When you retire, you stop adding money to your retirement account. Instead, you start removing it. The withdrawals matter because your money is in the market. If the market dips or there is a significant correction, you’re pulling cash from a shrinking pool of funds.
If this happens early in your retirement or before you retire, you’re exposed to the most significant risk. The reason is that this is when your investment is at its largest.
There are ways to mitigate the sequence of returns risk. For example, you can reduce exposure to volatility with a more conservative portfolio. Any retirement fund portfolio must be resilient and contain a mix of stocks that can fare well even when the market is unpredictable.
#3. Overconfidence in the Current Market.
A little prudence goes a long way. The market has been on a bull run for over a decade. Many investors have made significant and consistent gains, even in somewhat risky stocks.
While the current picture is rosy, it can’t stay that way forever. If your retirement plan is based on risky stocks continuously producing high returns, it’s time to stand back and do a little introspection.
Ask yourself, what happens when there is a market dip or correction? What if your portfolio drops by about 25%?
This overconfidence can affect stock picks too. In a bull market, it’s easier to pick winners. But once the markets drop or become stagnant, this process becomes far more challenging.
#4. Defining an Accurate Retirement Budget
Your retirement budget will influence what type of risk and returns your portfolio can generate. So make a reasonable retirement budget.
A well-thought-out retirement budget consists of two essential steps.
Calculate your essential expenses. These fixed outgoings are things like your household bills, taxes, insurance, and food. Additionally, budget for any medical costs you might incur.
Now, you’ll have an idea of your monthly outgoings.
Next up, consider ad-hoc expenses. These will be things like holidays, subscriptions and memberships, meals, and other entertainment. Factor in other things like treats for your grandchildren. A lot of this depends on how you plan to enjoy your retirement. If you want to be active and travel the world or go on cruises and the like, these costs can be pretty high.
Once you understand both columns of expense, you’ll have a better idea of what the best investment strategy looks like.
#5. Not Accounting For Taxes
Lots of people believe their taxes will reduce in retirement. Some even think they won’t pay any taxes at all. Unfortunately, this isn’t true. Retirement plan withdrawals and Social Security benefits can be taxable depending on your total income. Likewise, pension payments.
To avoid a scenario where your payments are less than you budgeted for, seek the advice of an account or financial advisor. One option is to move some of your savings into a Roth account.
There are lots of pitfalls you can face when planning your retirement. But a diversified portfolio with an acceptable amount of risk is a good start. Setting an accurate budget and accounting for the taxes you’ll need to pay will also help you avoid any nasty surprises.
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Alpesh Patel OBE