Top 5 Retirement Investing Myths: How to Invest the Right Way

 

Myth #1: I should put off saving for retirement until I earn a higher income

I always tell my clients: “you can borrow for almost anything in life, but you can’t borrow for retirement.” Like with any other monumental goal, you shouldn’t delay, but find a way to work it into your budget and current cash flow today.

If you are young enough, even a small amount of savings on a monthly basis can make a big difference in the long run. The reason? Compounding interest.

Compounding interest works best if you give it time. To illustrate let’s think about a snowball. If you make a snowball the size of your hand and push it down a steep snowy hill, what will happen to the snowball?

It’ll get bigger.

It’ll grow simply because you’ve given it momentum and time, not because you are adding any snow to the snowball yourself.

If you give the snowball a steeper and higher mountain to roll down, then it’ll have even more time to get bigger—compare a snowball rolling down a bunny hill in Vermont to one on double black diamond in Colorado.

Imagine source : The Philosophy Man

Imagine source: The Philosophy Man

We can apply this analogy to saving and investing for retirement: if you put a small amount of money into your retirement and it is invested, you’ve given momentum. The longer the time this money has in the market, the longer it has to possibly grow. I illustrate using the hypothetical example of Amy and John.

  • Amy starts investing at age 25. She invests $300 / month.

  • She invests monthly for 15 years, until she is 40 years old.

  • She completely stops saving money once she turns 40 (which is not recommended by the way!).

  • Her money is growing on average at 8% per year.

By the time Amy is 70 years old, the $54,000 she saved over the course of 15 years has grown into $1,050,000—all because of compound interest!

  • John, on the other hand, starts investing later than Amy, at age 40.

  • He also adds in $300/ month, but he does this for 30 years, twice as long as Amy.

  • Thus, John has invested $108,000 himself for retirement.

  • John’s retirement savings are also growing at a hypothetical 8% per year.

When John turns 70 his account has only grown to $450,000.

Amy saved for half the amount of time (15 years vs. 30 years) and adding in half the amount of money ($54K vs. $108K) than John, and yet…. her account grew to only twice as large as John’s.

Why? Because compounding interest works its magic overtime. There is a reason Albert Einstein called it: the 8th wonder of the world.

 

Myth #2: Investments in Retirement Must be Conservative

Many people believe that your investments should be based on your age: when you are younger, you should take on more risk with an aggressive allocation, and once you are ready to retire you should be totally conservative.

While there is some truth to this, it isn’t the whole story. When you are younger you have maybe 20 or 30 years to experience a market rebound if there were a market crash. You also presumably have an income from a job, so you’re not living on your retirement savings. Therefore, many young investors feel comfortable taking on more risk.

Retirees often cite downturns in the market and the depletion of all their savings in retirement as two major drivers of fear in their golden years. These investors believe they need their account to be conservative in order to weather the market depreciating, as they are taking money out of their accounts.

The problem with this logic is inflation: the price of goods and services becoming more expensive overtime.

In 1959, some American were still able to buy a coca cola for 5 cents. Today not only does a can of coca cola cost much more – around $1.50—but also there isn’t one item you could solely buy with a nickel.

This is one of many examples showing that the costs of basic goods and services is increasing overtime Others include: gas prices in the 1970s versus now, or the cost of dinner at a restaurant for a family of four even 15 years ago in comparison to today.

While the prices of goods and services are increasing, the worth of your dollar is decreasing. What a dollar can buy you today, it will not be able to buy you in 20 years.

The reason this is an important consideration is that according to the LIMRA Retirement Institute, 25 percent of 65-year-old men with average health will live to age 93, and a quarter of women in that category will live to 96. Given that we as humans are increasingly longer lives—well into our 90s—we need to make sure even in retirement we will be able to continue to buy the products we need and want, even 30 years later.

While stocks do take on generally higher risk, according to NYU Stern School of Business the S&P 500 (index composed of 500 stocks of the largest publicly traded U.S. companies) has returned an average of approximately 9.49% annually since 1928. Stocks’ more conservative counterpart, bonds, generally carry lower risk but that also means smaller returns. NYU found that the 3-month treasury bill had an average return of 3.38% annually since 1928.

With inflation during this period running at about 3.04%, the 3-month treasury bill barely keeps ups, and that’s before fees and expenses. According to the Bureau of Labor Statistics consumer price index, $100 in 1928 is equivalent in purchasing power to about $1,433.45 in 2017, a difference of $1,333.45 over 89 years.

Therefore, being too conservative in retirement could decrease the value of your dollar, disallowing you to live the retirement you planned on experiencing!

Source: NYU Stern

Source: Bureau of Labor Statistics consumer price index

 

Myth #3: Sell when the market is in trouble

This is false and doing so can cost you quite a bit of money in the long run! Here’s why:

If you could buy a designer handbag on sale—and truly believe there is nothing wrong with it—would you pay less, or would you wait to pay full price?

Most would say, buy the bag at a discount! So why do investors not act this way when it comes to buying stocks?

Many people’s gut reaction to a market downtown is to sell their stocks. During a recession, people are worried, that the stocks have already fell so much that they must pull their money out of the market in order to “stop the bleeding,” and save whatever is left.

Doing so means that you have now realized the loss. More often if you remain invested, the stocks rebound and increase overtime. You don’t want to pull out of the market, realize your losses, and miss out on the potential gains. Remember, market downturns are only losses on paper until you actually pull out your money.

You know from our compounding conversation that it is time—not timing—that allows us to capitalize on the market. Let’s say you do pull your money out during a recession and the market rebounds. You didn’t get back into the market quickly enough and now you’ve missed the 10 best days of the marketing rebound.

According to Putnam Investments, this means you missed out on 2.96% growth, or on a $10,000 initial investment, that means you’ll make $15,481 less.

You may think to yourself, but if there is nothing wrong with this stock, why has its value fallen? Unfortunately, if we’re experiencing a recession even healthy stocks take a tumble. It doesn’t mean there is necessarily an issue with the stock, but rather that there is just a bad overall economic situation.

Similarly, to a handbag going on sale, it is often a better time to buy certain stocks when they are on sale—i.e. their prices have decreased. A professional can often help determine what is a bad investment overall or what is just “on sale” due to a market recession.

 

Myth #4: Before you can retire, you need to have at least $1,000,000 saved

This is also false!

Being able to retire isn’t about achieving some arbitrary savings goal–it’s about having saved enough to maintain your desired lifestyle in retirement. In other words, how much you need saved in order to retire is determined by how much you plan to spend during retirement.

If you’ve ever wondered how some people can retire in their 30s (FIRE retirees), there’s a good chance the success of their plan depended on very low annual expenses versus saving a large nest egg.

The idea behind investing should be to meet your long-term financial goals, not have a contest with others. What is right for you may not be right for others.

Plus, it also depends on all your sources of income—not only what you’ve saved but also the guaranteed monthly income you may receive from social security, a pension, and perhaps an annuity.

The best way to really understand what you need in retirement is to contact a professional and run a full financial plan. A professional can help you understand your expected expenses in retirement and compare it to all of your available assets and income in retirement.

 

Myth #5: There's no need to worry about healthcare because of Medicare

When you turn 65 years old, you are eligible for Medicare. However, the benefits are not as simple as they may seem, including out-of-pocket expenses, shopping around for the best Medicare supplements, and understanding what is covered—and more importantly—what isn’t. Luckily we have a guide to Medicare myths which you can access by clicking here.