Financial literacy seems like a simple concept to grasp but it’s something many Americans continue to struggle with. A new survey from Stash highlights some of the shortcomings investors have when it comes to good personal finance habits.
For example, 41 percent of respondents in the financial literacy survey weren’t aware that a diversified portfolio is a safer investment than a single stock. Thirty-eight percent didn’t understand the basics of compound interest.
That kind of knowledge gap is something you can’t afford when investing for retirement security is the goal. With Financial Literacy Month underway, absorbing these vital lessons can be a valuable resource and help raise your personal finance IQ and save money.
[Read: How to Invest in Retirement.]
Start early. This may be the most important resource that you can have to further your retirement goals, says Sean McDonnell, a certified financial planner at Advance Capital Management in Southfield, Michigan.
“The hardest-working dollars you’ll ever save are the ones you set aside early in life,” McDonnell says.
He offers an example of why harnessing the power of compound interest early on matters for people looking to save money.
For someone earning $80,000 to set aside $1 million by age 65, they’d have to save 8 percent of their pay if they start at age 20; 18 percent starting at age 35; 55 percent starting at age 50,” McDonnell says. “The 20-year-old must set aside $265,000 out of their cash flow, but the 50-year-old must save $670,000 out of their own pocket because they have less time to earn.”
Avoid excuses. Thomas Lowry, president of Atlanta-based Georgia Wealth Advisors, says investors need to avoid falling into the “I can’t afford to save” trap.
“If you feel you don’t make enough to save, start small,” Lowry says. “If you can get in the habit of living off 90 percent of your income, saving won’t seem like a big deal.”
Lowry says that if saving 10 percent isn’t doable, to shoot for 5 percent instead. If you can’t do at least that amount of money, then it’s time for Plan B.
“If you feel 5 percent is too much, then I recommend doing one of two things. You should either decrease your spending or find a way to increase your income,” Lowry says.
Pace yourself appropriately. When it comes to investing for retirement, students of financial literacy know that slow and steady wins the race, says Drew Horter, founder and CEO of Cincinnati-based Horter Investment Management.
“When you start to become more aggressive, you could be more apt to make mistakes and have more drawdown in your portfolio,” Horter says. “I always remind clients that if you lose 50 percent in your portfolio, you need to make 100 percent to get back to where you were.”
Stephanie C. McElheny, manager of financial planning at PNC Investments in Pittsburgh, offers an example how important maintaining the right pace can be.
McElheny says that assuming a 30-year investment window, it’s more impactful to invest $5,000 per year at 7 percent beginning now, rather than wait 20 years and invest $20,000 per year at 14 percent. At the end of their respective investment periods, Investor A would have $472,304, compared to $386,746 for Investor B.
[See: 10 Skills the Best Investors Have.]
“As you can see, starting late but saving four times as much at double the rate of return still results in a lower ending balance than saving a much smaller amount earlier at a much more moderate rate of return,” McElheny says.
Taxes matter. Many investors tend to think of diversification only in terms of their asset allocation, but taxes are another important dimension of your investment strategy.
Jessica Landis, director of financial planning at Philadelphia-based Janney Montgomery Scott, says that in building wealth, investors often overlook the value of having multiple sources of retirement income that are taxed differently.
“Many people focus on investing in their 401(k) to get a tax deduction now because they believe they’ll be in a lower tax bracket in retirement but that may not be the case,” Landis says.
Landis says having only qualified funds set aside for retirement can make handling unexpected expenses like medical bills or home repairs more challenging. That may cause you to deplete those funds more quickly than planned or increase your tax liability. Having multiple investments to draw from can be a resource to help downplay the impact of taxes.
Be realistic about risk. Taking on too much risk — or not enough — can skew your returns off-course and be harmful to your retirement outlook.
Jay Ferrans, president of JM Financial & Accounting Services in Southfield, Michigan, recommends that investors be clear about where their risk boundaries lie.
“I never advise a client to take on more risk than they’re comfortable with,” Ferrans says. “This is a plan for disaster.”
At some point, says Ferrans, their portfolio will experience a market correction. With the extra risk factored in, losses may prove too large for investors to stomach, causing them to sell in a panic.
Marcy Keckler, vice president of financial advice strategy at Ameriprise Financial in the Minneapolis-St. Paul area, offers a simple test for gauging how risk tolerant you are.
“To determine your level of risk tolerance, ask yourself this: would you be more upset because you lost the money or because you lost out on the opportunity to make money?” Keckler says. “Everyone has different comfort levels when it comes to their hard-earned savings, so determine the best fit for you and your future goals.”
Leave emotions at the door. Lou Cannataro, a partner with Cannataro Park Avenue Financial in New York, says knee-jerk reactions are something investors must be careful to steer away from — particularly during financial literacy month.
“Most decisions in life, and especially when it comes to investing, are driven by two emotions: fear and greed,” Cannataro says. “If you’re making investment decisions driven by these emotions, you’ll most likely wind up buying high and selling low, time and time again.”
Cannataro advises investors to find ways to neutralize those emotions and focus on the long-term goal at hand, rather than the short-term noise in the marketplace.
[See: 7 Stocks to Buy for the Baby Boomer Retirement Wave.]
Balance cost with performance. Minimizing investment fees is important but it shouldn’t come at the cost of higher returns.
Phil Simonides, senior vice president at McAdam in Tyson’s Corner, Virginia, says investors need to avoid being penny-wise and pound foolish with their investments.
“The primary metric by which investors should evaluate the cost of their investments is whether it’s more valuable to pay someone else to invest their money or to do it themselves,” Simonides says. “If an investor’s only criteria is cost, they’ll end up buying something that may not perform as well because it’s cheap.”
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7 Retirement Investing Lessons to Master for Financial Literacy Month originally appeared on usnews.com
