Retiring early is the exception, rather than the rule but a sizable share of American workers have it in their sights. According to a 2016 Willis Towers Watson survey, 27 percent of employees expect to retire before age 65.
If early retirement is the goal, proper planning is critical. As you work to build a portfolio that can sustain your retirement income needs, watch out for these potentially costly pitfalls.
Avoid the performance-chasing trap. When you’re dreaming of an early retirement, making rash decisions with your money is the last thing you want to do, says Shelly-Ann Eweka, a financial advisor with TIAA in Denver.
“Chasing performance or trying to time the market is a risky bet that even the most seasoned investment professionals have a hard time doing,” Eweka says. “If you constantly choose investments based on yesterday’s top performer or abruptly sell investments based on the daily news, you may end up hurting your investment returns. You have to be right twice: the day you buy and the day you sell.”
[See: 10 Financial Perks of Getting Older.]
David A. Schneider, a certified financial planner and principal of Schneider Wealth Strategies in New York, says that in many cases, so-called “hot” investments have already begun to cool off by the time investors take notice.
“By the time it’s apparent that an investment or strategy is truly extraordinary, there’s a good shot that performance is about to mean revert and start looking a lot more ordinary,” Schneider says. “Buying what made someone else lots of money yesterday isn’t going to make you more money today.”
For investors banking on an early retirement, focusing on long-term considerations rather than short-term gains is preferable for building lasting wealth. That involves understanding how long your money needs to last.
“Whenever a person is planning on retiring, a key concern is how long you’ll need to live off your hard-earned savings,” says Megan Yost, head of defined contribution participant engagement for State Street Global Advisors in Boston.
Yost says that for early retirees, it’s important to recognize that your savings may need to stretch over 30, 40 or even 50 years. In that scenario, chasing performance, trading too frequently or making snap decisions can be counterintuitive to achieving your goals.
Remember to rebalance. Rebalancing serves to keep your risk tolerance and asset allocation on track, both of which become even more important when you plan to retire ahead of schedule, says Mimi Schanzlin, managing director of United Capital’s office in Buffalo, New York.
“With a shorter time frame, an investor no longer has the luxury of time to recover from mistakes,” Schanzlin says. “No one knows which market segments will outperform from year to year. A globally diversified portfolio that’s rebalanced on a timely basis is a sound strategy for investors who are looking to participate in the growth potential of various market segments over time.”
Scott Michalek, a senior financial advisor at Philadelphia-based Wescott Financial Advisory Group, says regular rebalancing is part of a disciplined approach.
“You need to periodically rebalance your portfolio to sell overvalued asset classes and purchase undervalued asset classes,” Michalek says. “This is sometimes difficult for investors to do since it feels like you’re selling your winners and buying the losers.”
Michalek says investors need to know which assets are going to provide sufficient cash flow to replace their monthly income once they retire, particularly if retirement is closer on the horizon.
Don’t underestimate inflation’s impact. Inflation can deal your retirement assets a serious blow, significantly reducing your purchasing power. The effects may be felt even more deeply for early retirees, whose savings need to bridge a wider time span compared to the typical retiree.
“Retiring early is a double-edged sword. Your money has to last longer, plus you have to account for inflation,” says Steve Anzuoni, a retirement income certified professional and owner of Fairway Financial Insurance Agency in South Yarmouth, Massachusetts.
[See: 7 Stocks to Buy for the Baby Boomer Retirement Wave.]
Anzuoni says that an early retiree should be considering investments that are designed to mitigate the impacts of both inflation and longevity, while providing income for life. Annuities, says Anzuoni, satisfy all three of those conditions.
“Not only can [annuities] provide a guaranteed lifetime income, which solves the longevity concern, but many products also have the opportunity to increase income based on index gains, which can account for inflation concerns,” Anzuoni says. “[It’s] a real win-win situation.”
If you’re considering an annuity as part of an early retirement strategy, pay close attention to how the insurance company selling the annuity is rated. When comparing annuity products, be sure that you understand how frequently benefits are paid, how long you’ll be able to enjoy those benefits and the costs associated with purchasing an annuity.
Double your efforts to diversify. A portfolio that lacks proper diversification can be devastating to your early retirement plans.
“A great way to suffer a financial reversal that derails your retirement is to have all or most of your money in one stock that takes a dive,” Schneider says. “Even if that one stock is the reason you have the money you do, be glad for your good fortune, then diversify. Anything can happen to one company and it may not recover, even if it always has in the past.”
Diversification is also important in terms of where you’re investing from a tax perspective.
“Tax efficiency is an important consideration for early retirees, especially if they plan on retiring before age 59.5,” says Rich Ramassini, director of strategy for PNC Investments in Pittsburgh. “Money that’s been saved in a 401(k), individual retirement account or another tax-deferred retirement vehicle may be subject to penalties and taxes if taken out before age 59.5.”
With that in mind, you have to consider how the tax structure of your various investment accounts may affect your drawdown rate and income once you retire. Early retirement also may also mean bridging the gap temporarily until you’re eligible for Social Security and Medicare benefits.
Ramassini says keeping a mix of nonqualified and qualified money can help to minimize the tax bite if you opt to retire early, since non-qualified assets can be taxed at preferential rates and aren’t subject to an early withdrawal penalty.
Creating an early retirement strategy that doesn’t allow you to mix things up can be a potentially fatal mistake, Schanzlin says.
[See: 10 Ways to Avoid the IRA Early Withdrawal Penalty.]
“It’s important to have an investment portfolio with flexibility,” Schanzlin says. “While today, the goal is an early retirement, that may change. An investment program with flexibility is important so adjustments can be made as life presents different challenges that often require changes to your initial plans.”
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4 Mistakes That Can Derail Your Early Retirement originally appeared on usnews.com
