The onus is on you to get your own planning right. Paul Clitheroe reviews the ten biggest retirement planning mistakes – and why you need to avoid them.
For past generations, retirement planning was something of an after-thought, if considered at all. It was simply a case of paying off the family home, tucking away a few shares, bonds and some cash and relying on the safety net provided by the age pension to get by. But in the twenty-first century, this is no longer enough. In fact, industry studies suggest many couples plan to live on more money ($30,000 pa) than the Age Pension currently provides (around $19,000 annually).
So, the implication is, if individuals want to live well in retirement, the onus is on them more than ever to start saving as early as possible, establish their retirement goals, to evaluate the myriad of investment options and be aware of the risks involved. At the same time, with this greater investment complexity, it’s also possible for investors to get confused and make mistakes that can affect retirement savings. In this article, I will look at some of the more common investment mistakes, the signposts to look out for and strategies for turning mistakes into winners. Let’s start by looking at probably the most common mistake, “Failing to Plan”.
1. Failing to plan for your financial future
“Fail to plan, plan to fail” is just so true when it comes to investing today. In fact, the recent ANZ Survey of Adult Financial Literacy in Australia, said only about 37 per cent of adult Australians had worked out how much they needed to save for retirement. Look, the money just won’t appear in your bank account the day you retire and this is where a financial plan is so important. It is q bit like a road map that indicates where you want to go (a comfortable retirement) and the best way to get there. The plan should contain investment advice and information about the level of risk attached to your investments. A good plan will also address issues like what insurance you should consider, your taxation position, cash flow (budget) as well as any retirement and estate-planning issues.
2. Not having a budget
Put simply, budgeting is the most effective tool there is to get and keep your finances under control. A budget tells you where you money is going, where you can cut back and where you can save. Look, I know there’s no denying cutting back on your spending is difficult when there is so little fat to trim in the first place. But no matter how much you earn, it is a question of taking co troll of your money. And this means managing your cash flow, which can only be achieved through budgeting.
A budget will also give you a much better idea of where you money is actually going. It is estimated that people regularly spend between $50 and $300 each month that they can’t account for. Yet this money could be used to pay off debts like a credit card or mortgage or be added to your retirement savings.
3. Leave your money in the bank
Sure, the bank is a terrific place for your everyday spending money but it’s no good for your investment money. If you really want to stick with the bank, don’t leave money in it, buy shares in it. Shares (and property for that matter) present more risk than cash and in the early days may actually generate little or even negative returns. On the other hand, shares and property generate capital growth over the longer term and returns may be taxed favourably.
4. Panicking at the first sign of trouble
The road to successful investing is fraught with many obstacles, as share-market investors can attest! The successful investor takes minor setbacks in their stride, remembers not to panic and sticks with the original investment strategy. If a quality investment (like shares or property) suffers a decline, it is generally the worst time to sell. Selling will only cost you money. But if you hang on and even buy more during a down-turn, you’ll be better off when the investment recovers.
5. Chasing historical performances
A few years back, the Economist magazine produced some interesting research that illustrates the folly of chasing past performances, The research showed how if an investor started with $1 on January 1 1900 and then hypothetically predicted the best investment market every year up to 2000, the result would be a massive $9.6 quintillion (before tax) windfall. However, if an investor had invested in the previous year’s high-flier (a mistake made by many investors) every January 1, the initial stake of $1 grew to only $783 before tax. The lesson here is don’t take too much notice of past performance and focus more on what could affect an investment in the future.
There are other mistakes investors make too, such as falling for the charms of get rich quick schemes, being swept up by media hype about certain investments and miscalculating the level of risk you are comfortable with. What I mean here is being aware of the maxim: the higher the risk, the higher the return. Many people take on more risk than they are comfortable with to make a quick buck. But when the investment falls short, they’re left in a difficult place financially.
Finally, it is important to be aware of the common investment mistakes, but also if you get it wrong, it’s not the end of the world. Simply learn from it and move on. Alternatively, if you are unsure about an investment move, talking it through with a qualified financial planner could prove to be a smart move. But at the same time, employing the services of a financial advisor is not a sign you can simply hand over holus bolus the responsibility for your money either.
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6. Timing the market
You don’t have to be Einstein to see why some people will try to get their market timing right. Anyone who can consistently pick upward share movements will end up very rich, in just the same way a punter who can consistently pick winners will do very well. But like picking winning horses consistently, getting your market timing right is easier said than done.
An excellent example of the folly of trying to time the market was demonstrated by a study of the US share market between 1980 and 1993. The study found that if an investor kept their money in the market during this period (1980 to 1993) they would have averaged a 15 per cent return annually. However, if they missed just ten of the best trading days during this period, their return was reduced to 11.9 per cent. If you missed the forty biggest days, this reduced your return to 5.5 per cent.
So those thinking of quitting their jobs and jumping into day trading take note. Rather than trying to beat the market, I would advise investors to buy good quality stocks and stick with them for the long term. By the long term, I mean for at least five to seven years – and you’ll be amazed at how quickly your money begins to grow.
7. Not diversifying
Having all your eggs invested in one basket could prove to be risky, especially if that basket topples over (eg share-market October 1987, property market early 1990s and technology shares, April 2000). Spreading your money across asset classes like cash, fixed interest, shares and property can produce more consistent returns over time.
8. Not doing your research
During the tech bubble of the late 1990s, it was not uncommon for investors to take share-market advice from family, friends, work colleagues and even well meaning taxi drivers. What compounded this common mistake was that many then acted on this advice without doing any research for themselves. Always research any investment (buying property off the plan, managed investment or new share listing) and find out who is behind it. Undertaking a period of research also gives you time to coolly evaluate an investment that initially looks good but on closer examination might in fact not be appropriate.
9. Investing in tax schemes
When it comes to tax and investment, please be cautious about tax schemes. Tea-trees, movies, olive oil and ostriches. You name it, I’ve seen it – tax schemes in every colour, shape and size that are usually bought in a desperate panic in June by people with a tax problem. My advice is quite simple. With any investment scheme, unless you really understand the nature of the investment, don’t do it. Looking at my own clients, I find that those who have simply concentrated on minimising their tax in the usual ways, paid what they owed and concentrated on a sensible investment strategy end up miles in front.
10. Left it too late
Starting young and saving small amounts regularly is the most certain path to financial independence. But at the same time, it’s never too late to start planning for your retirement either. I have clients of all ages – and many older than 55 when they first approach me. The first step is to pay off the mortgage, if you haven’t already done this. This can be achieved by increasing repayments if this is possible. Once the mortgage is cleared, then it’s time to consider other investment options.
One option here is to consider topping up your super through ‘salary sacrificing’. This is a simple strategy where you can rearrange your pay so that your employer pays a proportion of your salary (previously paid in after-tax dollars) to you in pre-tax dollars into your super fund. By investing more money in a super fund you also get exposure to a range of managed investment choices – balanced, capital stable and growth fund options. By doing this you’ll soon find that you are better placed come retirement.
An edited version of The 10 worst retirement planning mistakes, first published in YL (Your Life, Your Retirement) magazine