Since launching my company’s investment advisory service for retirees, True Link Financial, my colleagues and I have spent a lot of time talking to people about their financial plans. Here are five of the most common mistakes we’ve seen and how retirees can avoid them:
Mistake No. 1: Thinking you can beat the market
Even professional traders who buy and sell individual stocks rarely outperform the market over the long term. Known as an “active” strategy, moving in and out of individual stocks is a recipe for excess volatility and can put your investments at risk.
If you’re pursuing an active strategy, however, there are a couple key things you should be aware of:
When you buy a stock because you think it will go up, you’re not betting on the company’s performance, you’re betting that it will go up more than professionals, whose full-time job is to study that stock. And they also have superfast computers that make trades based on reports not even widely known yet.
Higher-volatility strategies can be misleading, with investment performance results that often look better than the market during most years, but perform much worse than the market every once in a while. That means, even if you’ve beaten the market over the last 10 years, you could be teeing yourself up for a big, unexpected loss.
Mistake No. 2: Keeping all your money in cash
The complete opposite of the at-home trader is the person who keeps all of his or her money in cash. By that, I mean, in bank accounts or money-market mutual funds. Some retirees think: Cash feels safer and seems like a good idea — at least I know I’m not getting ripped off.
The problem here is that you won’t keep up with inflation. This is a particular problem for retirees who face health care costs rising much faster than the cost of living.
Mistake No. 3: Putting a little money in a lot of places
Reducing your risk by diversifying your portfolio is generally smart. But “diversification” doesn’t mean saying yes to every sales pitch.
I’ve seen retirees with accounts at many, many financial institutions. Sometimes, part of their investment portfolio is one place, in a high-risk mutual fund, and another part is somewhere else, in a risk-avoiding mutual fund.
The focus of diversification should be on diversifying the underlying assets — stocks, bonds, real estate and the like. So while having 20 mutual funds at different financial-services companies may appear diverse, it really isn’t if most of those funds invest in the same types of securities. You could have less diversification this way than if you just split your investments 50/50 in one broad-based stock index fund and one broad-based bond index fund.
If you have a broker or a financial adviser, you can ask that profession for a look-through analysis to see what the underlying assets are in any of your mutual funds. Make sure those underlying holdings are diverse.
Mistake No. 4: Steering (too) clear of your savings
If you plan on leaving money to children, charity or other loved ones, it’s important to plan for that. If not, don’t be afraid to dip into your savings during retirement — that’s what it’s there for!
But many retirees struggle to make the transition from saver to spender. Working with an adviser to create a realistic financial plan may be enough to give you the confidence to take that trip you’ve always dreamed of, make that donation to a charity you care about or spend a little more on yourself.
If you’re afraid to spend or make a donation because you’re worried about losing money due to a downturn in the stock or bond market, insurance may help. For instance, we’ve found that, people who use a deferred annuity (where you give an insurer money and it starts paying you back with monthly, fixed installments starting at 85 or so) typically end up with greater lifetime spending power than those who plan to rely on their savings for these years.
Of course, I’m not recommending emptying your bank account; it’s important to talk to a financial planner and figure out what expenses you should be prepared for in the future.
Mistake No. 5: Feeling trapped by real estate
For many retirees, their house is their primary asset. And while this can be great news for your financial future, it can make the difficult decision to sell your family home even harder.
When deciding to sell your home, it’s normal to worry about putting yourself in a position where you can’t afford rent or losing your ability to leave an inheritance. But until you crunch the numbers in a spreadsheet, you can’t be certain how things will turn out.
In some cases, selling your home can let you buy something less expensive, live off the difference and invest the money or cover rent with the resulting assets. You could actually end up with more money to leave behind, instead of less.
Three ways to avoid these mistakes
So, how can you avoid making these mistakes? Three ways:
First, consider the risks you want to avoid— like out-of-pocket long-term care costs, medical expenses or property repairs and outliving your assets. Figure out a strategy to address them, either using your assets or carefully chosen insurance products.
Second, use a simple, broad-based, and diversified investment approach —something you could easily explain to a friend.
And third, based on conservative assumptions, figure out how much you can afford to live on. Then, use that money in the best way possible to enhance your quality of life.