Your 40s are the time to become more serious about your financial plan. You have been working hard to accumulate assets and grow your family. For the first time, you may need to consider more than just cash flow management and investment planning. Hopefully, the healthy financial habits you developed in your 30s have put you in a strong position to meet your long-term goals. Your career and personal life are in full swing. Your children are in high school or maybe even heading off to college. For the first time, retirement may seem like a realistic goal. Now is the time to make up for previous financial shortcomings, consider your immediate and longer-term financial and personal objectives, and yes, prepare yourself for the next phase of life – pre-retirement.
As part of our Intergenerational Family Wealth Planning offering, we are writing a series of articles focused on the most common financial mistakes people make in different decades of their lives. Today, we discuss the mistakes people make in their 40s and provide some tips on how to set yourself up for long-term financial success.
Mistake #1: Compounding Prior Mistakes
The common financial planning mistakes made in your 20s and 30s can severely impact your financial future if not remedied by the time you enter your 40s. These mistakes may include:
- Not having a financial plan detailing your short- and long-term goals;
- Overspending;
- Not having a budget;
- Not developing a formal savings plan that includes building an emergency fund and maximizing retirement savings;
- Not openly communicating with your partner about money, and
- Not maintaining a healthy credit score.
Taking the time now to consider all these things, and putting together a plan of action, can make a big difference to your financial success. If these things feel overwhelming to you, speak with a financial planner who can help you organize your thoughts and prioritize your tasks.
Mistake #2: Not Having an Estate Plan
There is a misconception that an estate plan only ensures your wishes are met when you die. Estate plans can also protect you if you become incapacitated. It incorporates three documents:
- A Will details how you would like your estate managed after your death. It includes the names of who will receive your assets, as well as who will manage your estate (executor role). It also appoints the guardian of your minor children. If you do not have a Will, the State government will make decisions for your family, a potentially costly process that can erode the value of the estate.
- The Durable Power of Attorney names who will act on your behalf in financial matters if you become incapacitated. Their responsibilities can range from writing your monthly checks to making tax and business decisions on your behalf.
- An Advance Medical Directive (also called a Living Will or Health Care Proxy) names the person who can speak to your medical professionals if you are unable to act on your own volition. They will represent how you wish to be treated in end-of-life situations.
Selecting the individuals to represent you in these circumstances can be hard to do, and we see many people delay the estate planning process because of these difficult decisions, especially when it comes to the guardianship of minors. However, we highly recommend getting the documents in place sooner rather than later, to protect you, your heirs, and your assets. Remember, you can always amend or update them in the future. You should also review them every few years to ensure they continue to reflect your wishes.
Mistake #3: Not Updating Your Beneficiaries
Not all assets are governed by the wishes outlined in your Will. Certain financial assets, such as retirement accounts, annuities, and life insurance policies, pass based on the beneficiary designations selected. Each of these types of assets requires you to name a primary beneficiary to receive the assets at your death, and a contingent beneficiary, who will receive the assets if the primary beneficiary has predeceased you. Common mistakes we see are:
- Not naming a primary or contingent beneficiary
- Not updating the beneficiary when you get married. Typically, single people will name their parents or siblings and forget to update the beneficiary to their spouse after they marry.
- Not leaving assets to minor children in Trust
- Not updating a beneficiary after a divorce. And yes – the named beneficiary will receive the assets by law no matter what your wishes may have been.
You should review the beneficiaries of these accounts and policies periodically to ensure they continue to reflect your wishes.
Mistake #4: Overspending on Big Ticket Items
You work hard, and you deserve nice things. Perhaps you’ve always dreamed of owning a boat or a beach house, or you have your sights set on a large home in an upscale neighborhood. It’s important to remember that the more expensive these assets are, the more expensive the upkeep is (i.e., insurance, utilities, repairs, maintenance, and furnishings). Purchasing big-ticket items can lead to overspending and will blow your budget. Most people who haven’t saved enough for retirement blame overspending on a big-ticket item as the cause. We recommend prioritizing retirement and college savings before spending on that luxury car or other significant purchases.
Mistake #5: Saving for College Before Saving for Retirement
We all know the impact student loans have had on college graduates over the last 20 years. You may not want your children to face the same issues. While saving for your child’s college education is a noble endeavor, it should not come at the expense of your retirement. If you choose to fund college first, you may need to change your long-term plans, such as working longer or changing your retirement goals. Remember, you can always get a loan for college, but you might not be able to borrow for retirement.
When saving for college, consider opening a 529 College Savings Plan, which allows contributions to be invested for growth and are withdrawn tax-free when used to pay for the qualified education expenses for the named beneficiary on the account. Also, once your child enters their junior year of high school, begin researching what student financing might be available, whether it be loans or scholarship offerings.
Remember your end goal. You don’t want your child bogged down in debt. That includes not having to support you financially, due to a lack of retirement savings.
Mistake #6: Not Being Properly Insured
Insurance is something we pay for and hope we never need. But being properly insured is an important aspect of every financial plan as we strive to reach financial independence. The types of insurance you should strongly consider are as follows:
- Medical Insurance, which can typically be obtained through your employer and provides coverage for routine and emergency situations.
- Property and Casualty Insurance includes homeowners and renter’s insurance, auto coverage, and liability coverage, which provides additional protection over and above home and auto coverage. You can learn more about these by reading our two-part series on Property and Casualty Insurance: An Often-Overlooked Part of One’s Financial Plan and How the Auto and Liability Insurances You Select Can Impact Your Financial Plan.
- Disability Insurance provides income replacement if you cannot work due to illness or injury (see Mistake #7 below).
- Life Insurance provides for your beneficiaries in the case of your premature death (see Mistake #8 to learn more about this).
Life insurance and disability insurance may have felt like luxuries in your 30s. But they become more critical as your lifestyle and salary increases. Being underinsured in any of these areas could cause an economic loss for your family, which could derail your plan for financial independence.
Mistake #7: Not Protecting Your Income
What would you do if you were sick or injured and unable to work? How would you replace your income to cover your living expenses? Not having income replacement protection, known as disability coverage, can have a profound impact on your financial independence. Long-term disability insurance can replace 50-60% of your monthly pay, should you become incapacitated. We recommend asking if your employer offers a group long-term disability policy, or consider purchasing a private plan, which is portable if you were to change jobs. These policies can be complicated, so speak with an insurance professional who works in your best interest.
Mistake #8: Not Having Proper Life Insurance
Life insurance protects your family in the event of your premature death. Often, people procrastinate because they feel the premiums are too high. Premiums are determined by your age, health, the amount of coverage, and the type of policy you desire. Thus, delaying until you’re older (and possibly not as healthy), will undoubtedly cause the cost to increase.
The mistakes we see include not getting a long enough term and not having the proper coverage amount. Consider what (and who) you are trying to protect. The policy should be in place long enough to achieve your goals, such as providing for your kids until they graduate from college, or until your mortgage is repaid. The amount should ideally include income replacement, as well as your mortgage value and the estimated cost of college expenses.
Employers typically offer a group life insurance policy. However, relying solely on this can be a mistake because these policies usually end when you change jobs. Some are portable, meaning you can continue to pay the premium to keep the insurance after you leave your employment. These premiums are usually more expensive than what your company was paying because you are no longer receiving the group premium rate. A better alternative is to consider private coverage and review it periodically to determine if anything has changed that would warrant a different amount or term.
Mistake #9: Not Monitoring Your Credit Rating
Identity theft is one of the fastest-growing crimes in the U.S. Nearly 60 million people were impacted by identity theft in 2018, according to a survey by The Harris Poll. You have invested time and energy building up a good credit score through the years, yet if someone steals your identity, it could ruin all your hard work in minutes.
One way to reduce the risk of identity theft is to monitor your credit reports periodically throughout the year. Everyone is entitled to one free copy of their credit report every 12 months from each of the three nationwide credit reporting companies. You can order them online at www.annualcreditreport.com. To maximize this benefit, we recommend requesting a report from a different agency every four months. This strategy allows you to keep better tabs on activity throughout the year. Should you find a mistake (and it does happen), take steps to rectify it immediately.
If you are concerned about identity theft or have experienced a recent breach, consider using a credit monitoring service, instituting a credit freeze, or placing a fraud alert on your credit file. A credit freeze locks down your credit. A fraud alert will protect your credit from unverified access for up to one year.
Mistake #10: Investing Too Conservatively
The fact that you are getting closer to retirement does not mean you should be too conservative with your portfolio allocation. You likely have 20 years until retirement and another 20-30 years to live in retirement. Your time horizon (which represents when you will need the funds), allows you to ride out stock market volatility by giving the market time to recover, combined with your continued contributions to the portfolio. There has never been a 20-year period in the market where stocks have generated a negative return. So do not overreact to current market conditions. Never let emotions dictate your investment decisions in the short-term and do not try to time the market. These are recipes for the underperformance of your portfolio.
Your risk tolerance is dictated by how much volatility you can withstand. This helps to set the diversification (asset mix) in your investment portfolio. For example, equity investments (stocks) are generally more risky investments than fixed-income investments (cash and bonds). Equities also tend to generate higher positive returns than their fixed-income counterparts over the long-term. Equities are needed in a portfolio if you are looking to beat inflation over the long-term and maintain your purchasing power.
During the accumulation phase of life, a bear market provides an opportunity to purchase investments at a cheaper cost (buy low). The newer shares you buy will grow when the market transitions back to a bull market, which happens much more frequently over time than a bear market. Be more conservative with funds that are required for short-term purchases (such as a home), and more aggressive with assets with longer time horizons (such as those held in retirement accounts).
Do you remember how far away your 40s seemed when you were younger? Well, it’s here, and your 50s and yes, even retirement, will be here faster than you think. Achieving financial independence is no longer a dream; it is now the goal.
