In study after study, 401(k) investors come up short of the amount they need to sustain a pre-retirement lifestyle during their golden years. The reason for the failure? Lack of planning. To avoid finding yourself in short of cash just as your leisure years begin, consider these six tips. (For more on analyzing your 401(k), see Is Your 401(k) On Track?)
TUTORIAL: 401(K) And Qualified Plans

1. Have a Number in Mind
Conventional wisdom tells us that saving for the future is the key to a happy retirement. In keeping with this mandate, investors put money into tax-deferred retirement savings plans. If they manage to save the maximum permitted by the plan, they often turn to tax-aware investments in order to keep their nest eggs growing and their tax liabilities low. On the surface it sounds great, but is it enough?

Blindly pumping money into your investments and hoping for the best is not an intelligent way to plan. Instead of just looking at the amount risk they are willing to take or the amount they can afford to put away each month and using that as a guide for their savings, smart investors set goals. They figure out how much money they will need to save in order to fund their desired retirement lifestyle, and then they save and invest accordingly. (To help with retirement planning, check out 5 Retirement Plan Moves TO Make Before Year-End.)

2. Monitor Your Results
Having a specific hard-dollar goal enables investors to track their progress toward that goal and allows investors to make adjustments to their portfolios in accordance with that progress. Consider, for example, that for many years, mutual fund companies suggested that their 401(k) plans would deliver average returns of 8% per year.

This hypothetical rate of return suggested that, on average, investors would just about double their money every eight years. Unfortunately, average returns don't always work out so well in real life. Consider, for example, the 10-year period from 2000-2010. Instead of doubling every eight years, 10 years of investing in a well-diversified stock fund like Vanguard Total Stock Market Index Fund delivered a paltry 2.45% average annual return. A $10,000 investment on January 1, 2000 was a measly $12,744 on December 31 2010, a decade later.

The lesson for investors is clear: watch your balance. If it isn't where it needs to be, take action. Get more aggressive, save more, change investments, etc. Evolve your strategy to keep up with the ever-changing financial markets. (For another reason to review your retirement plan, read New Retirement Plan Limits For 2010.)

3. You Can Never Save Too Much
For years, mutual fund companies told 401(k) plan participants that investing less than 10% of their income per year was enough. "Invest enough to get the company match" was another piece of advice. Some "experts" even suggested that investors were saving too much. Those sentiments have fallen by the wayside. Today, some experts recommend that investors save 12-15% of their pre-tax income as a starting point. Increasing that rate each year is strongly recommended.

Common sense plays a role here too. We all know that a significant number of people reach retirement without having enough money. Yet, we never hear stories about retirees who find themselves awash in cash and wishing they had less of it. The bottom line here? Save more. In the worst-case scenario, you'll have saved so much more than you need that you will be able to retire early. (For more information, read Top 4 Reasons To Save For Retirement Now.)

4. Investment Diversification
Generations of 401(k) investors were told that diversification among stocks/bonds/cash was the way to protect their portfolios. As we have learned, there are periods of time where this idea simply doesn't work.

The next generation of investors would do well to diversify beyond the traditional offerings by allocating a portion of their assets to annuities, income generating real estate or other investments that are not correlated to stock market performance. (For more ideas on diversification, see Bear-Proof Your Retirement Portfolio.)

5. Don't be Greedy
More than a few retirees have a significant portion of their wealth invested in their former employer's stock on the day they retire. If they fail to diversify, they risk losing everything if/when the stock crashes. Similarly, investors often hold onto their investments even after the investments have risen significantly in value.

In both cases, there is value in learning your limits. If you have a princely sum in company stock, diversification is a great way to lock in your gains. If your other investments have done their job and you have enough of a nest egg to achieve your goals, move you money to more conservative investments. Remember that old saying about the value of a bird in the hand versus two in the bush! (For information on what to do when you have reached your goals, see 3 Ways To Make Your Retirement Funds Last.)

6. Have a Plan B
What if you do everything right but your investments still don't work out? Move to Plan B. You can choose to work longer, you can choose to change your lifestyle, or you can choose to do both.

Changing your lifestyle may require that you cut back on things you like to do. It may require moving to a less expensive home. It may even require relocating to a less expensive city, taking a roommate or moving in with a relative.

Just as you should be monitoring your investments during your working years, you should also be considering your alternatives. By taking some time to consider your alternatives before you need to make a choice, you will have a plan and be ready to act on it if and when the time to choose arrives. (If you choose to work longer, see Working Longer: Will It Hurt Your Retirement.)

Investing in the Real World
The financial markets are an imperfect tool. Relying on them subjects your future to the volatile and unpredictable nature of the investment returns financial markets generate. Despite these shortcomings, the financial markets are the primary retirement savings generator for millions of investors. Accept what you cannot change, and take an active role in monitoring your investments and making the changes you can in pursuit of your goals. (To read more on how retirement investing has changed, see The Evolution Of Retirement.)

Related Articles
  1. Retirement

    The 3 Most Common 401k Rollover Mistakes

    No one is born knowing the tax rules for 401(k)s and IRAs, but only dummies, scaredy cats and suckers don't buckle down to learn them.
  2. Investing News

    How Does US Social Security Measure Up Abroad?

    Social Security is a hotly debated topic. After examining the retirement plans of three different countries, the U.S.'s does not come out the winner.
  3. Investing

    Five Things to Consider Now for Your 401(k)

    If you can’t stand still, when it comes to checking your 401 (k) balance, focus on these 5 steps to help channel your worries in a more productive manner.
  4. Retirement

    The World's Most Luxurious Retirement Destinations

    If money is no object (or if you would just like to dream), these five spots are the crème de la crème.
  5. Professionals

    How to Protect Elderly Clients from Predators

    Advisors dealing with older clients face a specific set of difficulties. Here's how to help protect them.
  6. Professionals

    Social Security 'Start, Stop, Start' Explained

    The start, stop, start Social Security strategy is complicated. Here's what retirees considering it need to consider.
  7. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  8. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  9. Professionals

    How to Build a Financial Plan for Gen X, Y Clients

    Retirement is creeping closer for clients in their 30s and 40s. It's a great segment for financial advisors to tap to build long-term client relationships.
  10. Professionals

    Don't Let Your Portfolio Be Trump'd by Illiquidity

    A look at Donald Trump's statement of finances and the biggest lesson every investor can learn.
RELATED TERMS
  1. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  2. Backdoor Roth IRA

    A method that taxpayers can use to place retirement savings in ...
  3. Current Service Benefit

    The amount of pension benefit accrued by an employee who had ...
  4. Self Invested Personal Pension ...

    A tax-efficient retirement savings account available in Great ...
  5. Senior Move Manager

    Senior move managers (SMMs) help seniors downsize and relocate ...
  6. Medigap

    Also called Medicare Supplement Insurance, Medigap is health ...
RELATED FAQS
  1. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  2. Can my IRA be used for college tuition?

    You can use your IRA to pay for college tuition even before you reach retirement age. In fact, your retirement savings can ... Read Full Answer >>
  3. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  4. How do you calculate penalties on an IRA or Roth IRA early withdrawal?

    With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>
  5. What are the best ways to use your 401(k) without a penalty?

    The best way to use your 401(k) retirement savings account is to take normal distributions after you reach retirement age. ... Read Full Answer >>
  6. Is my IRA protected in a bankruptcy?

    All types of individual retirement accounts, or IRAs, recognized under the federal tax code enjoy substantial protection ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!