Avoid These 2 Mistakes in Your First Year of Retirement
Navigating the first year of retirement can be both exciting and daunting. While the freedom from work offers countless opportunities for leisure and personal growth, retirees may encounter many financial pitfalls—especially in the first year.
Even if you took advantage of the free money from employer matching in your employer-sponsored 401(k), these two mistakes can erode your retirement savings quicker than you think.
If you’re in your first year of retirement, avoid these common mistakes to make the most of this significant life stage.
Importance of Preparing for Retirement
You’ve heard the saying, “Failing to plan is planning to fail,” right? Well, nowhere is this truer than when it comes to retirement. In general, retirement isn’t a phase of life that tolerates a lack of planning well. Even worse, the repercussions of failing to plan can often be far-reaching and irreversible.
Here are some of the pitfalls you could encounter if you don’t adequately prepare for retirement:
Running out of Money
Perhaps the most dreaded consequence of poor retirement planning is running out of money. Imagine having to count every penny, unable to partake in any activities you’ve looked forward to for years. This could mean giving up on the traveling you hoped to do or downsizing to a more affordable home to avoid a risk of default. At worst, it can mean a complete reliance on a meager Social Security check—or even returning to the workforce at an age when you should be relaxing.
Another challenge that arises from a lack of preparation is the inability to retire when you had originally planned. If your savings accounts aren’t up to par or your retirement account hasn’t grown as you hoped, you might work beyond your full retirement age to make up for the financial shortfall. This delay can have a ripple effect on your life, affecting your health, family, and overall happiness.
Emotional Stress and Family Strain
Fiscal issues aside, failing to prepare can lead to immense emotional stress. The golden years you’ve been looking forward to can suddenly feel tarnished. This stress doesn’t stay confined to you; it spills over into your family life, causing strain in relationships. Your children or relatives might feel obligated to step in financially or emotionally, causing tension and resentment that could have been avoided.
Mistake 1: Underestimating Expenses in the Initial Years
You’ve made it to retirement, congratulations! However, let’s talk about a significant misstep many new retirees make, often within the first year: underestimating how much they will spend.
I’ve observed this trend firsthand over my years of working with retirees. Most people seem to have some “pent-up freedoms” they wish to explore once they clock out for the final time. Whether it’s travel, visiting family, or splurging on shopping and food, these exciting new ventures can cause your spending to balloon in the first few years of post-retirement.
What are “pent-up freedoms?” That’s what I call the desire to let loose once you have fewer responsibilities. Imagine holding your breath underwater and finally surfacing—the first thing you want to do is gulp in as much air as possible. Similarly, years of working and saving often lead to a burst of expenditure once the retirement gates open.
Best Practice: Budget
But you don’t have to skip out on the “fun money.” The key lies in preparation. If you’ve been saving for retirement diligently for over thirty years, you should make efforts to work some leisure spending into your plan. A smart way to do this is by setting up a separate “fun money” account. Financial advisors often recommend allocating a certain percentage of your retirement savings for discretionary spending, including anything from travel to hobbies.
To manage this effectively, consider using financial tools like budgeting software, which can help you categorize your spending. This will give you a better understanding of where your money is going and how much you can afford to allocate towards leisure without affecting your long-term financial health.
Mistake 2: Poor Investment Decisions
You’ve successfully navigated the first hurdle by budgeting adequately for the “fun money” in your initial retirement years. Now let’s talk about another pitfall many new retirees encounter, often within the first year of hanging up their work boots: leaving your 401(k) or other retirement investments allocated in the same short-term growth or higher-risk categories you’ve had during your working years.
This oversight can prove costly, especially since you’re entering the “red zone” of retirement planning.
The term “red zone” is used by financial experts to describe the years leading up to and immediately following retirement. Your investment choices matter more than ever during this period because a significant loss could derail your entire retirement plan. This is why it’s crucial to reconsider the risk factors in your current investment strategy, like market risks and interest rate risk.
Why Higher-Risk Investments Can Be Dangerous
It may have been acceptable to pursue higher returns during your working years by taking on more investment risk. However, doing so during the red zone can result in a severe blow to your retirement savings account, something you may not have the time or means to recover from.
Three types of risks are of particular concern here: market risks, interest rate risks, and liquidity risks. Market risks could shrink your investment portfolio, interest rate risks could affect the income from your fixed-income investments, and liquidity risks could make it challenging to convert your assets into cash when needed.
Your retirement years are not the time to be a passive investor. Engagement is the first step towards minimizing the risks of later-in-life investing. So, consider becoming more involved in understanding and adjusting your investment allocations.
Best Practice: Adjust Your Investments
Making timely adjustments to your 401(k), Roth IRA or other retirement plans can help you avoid retirement mistakes that could lead to a decline in your standard of living.
Sit down with a financial advisor and review your asset allocation, liquidity, and risk factors like market and interest rate risks. They can also help you understand how to balance your asset allocation between different types of investments and asset classes, such as stocks, bonds, and mutual funds, based on your individual needs and risk tolerance.
The goal is to align your investment choices with your unique risk profile and financial needs. Are you looking for stable, long-term growth? Do you need more liquidity in your investments? Answering these questions can help you and your financial advisor make decisions that empower you to feel confident and in control of your financial future.