No matter one’s age, people can have trouble motivating to save for retirement. The most common mistakes that investors often make depend on their life stage—and they frequently relate to behavioral finance. Simply put, certain behaviors can impede good choices, and our human tendencies can derail even the best intentions. That makes it vital for all investors to try to understand the human mind when it comes to retirement readiness.
A recently married couple has combined their finances. Together, they have more money coming in than ever before, but they also have more expenses in the form of mortgage and student loan payments.
These debts are normal and even necessary, but the principal of loss aversion means that, psychologically, they feel like a looming loss. For that reason, the couple is tempted to use whatever extra money they have—a few hundred dollars here and there—to pay down debts rather than invest for their future retirement.
The Expert Advice:
“Merging finances changes the whole picture, and the number one concern I hear from readers is that they have competing priorities,” says David Weliver, who founded his website, Money Under 30, to offer financial advice to young adults who were grappling with this sort of dilemma. “It’s an age of transition, of feeling that you’re just making ends meet but also need to save and try to get some traction.”
While it’s difficult to visualize retirement when it’s four decades away, a mortgage payment feels very real, particularly because not paying it is guaranteed to lead to trouble in the here and now. The key is to not think of your mortgage or student loans as debt; think of them as an investment that you’ve made in your future self.
With that in mind, Weliver recommends always keeping an eye on the bigger picture and striking the right balance between short- and long-term time horizons. “With mortgages and student loans at today’s rates, my advice would be not to prepay them and to invest instead,” says Weliver, who emphasizes that credit card debt and personal loans should still be prioritized. “If the stock market continues to do what it has historically, you should come out way ahead with retirement savings.” This is particularly true when one considers the power of compound interest, which means that starting to invest even a small amount early can have an outsize impact on retirement savings.
Take a couple with an annual household income of $63,600 and a $100,000 30-year fixed-rate mortgage at 3.5 percent, for a monthly payment of $449.04. If they increase their mortgage payment by $265/month, they’ll save more than $33,000 in interest and pay off their loan in half the time. However, put that extra money into a retirement fund instead, and it could result in 46 percent more in savings by age 70 ($1,061,170 vs. $726,304).
Once your perspective shifts to view a mortgage payment not as a loss but as a pragmatic financial decision, it can be placed on equal footing with the slow, steady growth of saving for retirement. From there, the math is simple: If you’re confident that your retirement savings can outperform the interest rate of your mortgage (as history has proven), then saving is the sound decision, no matter how small the amount.
“You don’t need to be heroic right away,” says Weliver. “Just start putting some percentage of your salary away—even if it’s 1 or 2 percent—and forget about it. The more you can get yourself to pretend that money doesn’t exist and invest it, that will better prepare you for retirement in the long run.”
For the overwhelming majority of people who don’t have the time or training to choose individual stocks, Weliver would recommend a target date fund. “I think that for 90 or 95 percent of people, that’s the way to go,” he says. “I like this stuff and I’m comfortable with it, and even I’m getting to the point where I think, Where am I going to find the time? The products are there to handle it for you. Why not do that?”
RISKS: Investing involves risk. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost, and it is possible to lose money. Past performance does not guarantee future results. Asset allocation and diversification do not assure a profit or protect against loss in declining markets.
The target date is the approximate date when investors plan to retire and may begin withdrawing their money. The asset allocation of the target date funds will become more conservative as the target date approaches by lessening the equity exposure and increasing the exposure in fixed income type investments. The principal value of an investment in a target date fund is not guaranteed at any time, including the target date. There is no guarantee that the fund will provide adequate retirement income. A target date fund should not be selected based solely on age or retirement date. Participants should carefully consider the investment objectives, risks, charges, and expenses of any fund before investing. Funds are not guaranteed investments, and the stated asset allocation may be subject to change. It is possible to lose money by investing in securities, including losses near and following retirement.
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