We like to think that we make rational financial choices, but that isn't always the case when it comes to our money. Our personal financial decisions are frequently influenced by our emotions. Due to our inability to think long term and our fear around losing money, we make bad investing decisions all the time. Luckily, you can take some pretty basic steps to protect yourself from your irrational side when it comes to preparing for retirement.
Automate your investing. First, you should automate your investing whenever possible. Automated investing keeps you stashing away funds even when it seems like money is tight in your everyday life. If also keeps you from frittering away your funds on spending that feels good now before you can save that extra cash.
The first step is to enroll in your employer’s retirement plan, which will automatically deposit a portion of your paychecks in an investment account. If you’re self-employed or your employer doesn't provide a 401(k), you can set up an automated deduction to a retirement or investment account at the beginning of each month.
Also, remember to automate increases in your investing. When you get a raise, direct at least part of the “new” money to your retirement account right away. If you never see it hit your checking account, you’ll be much less tempted to spend it frivolously.
Get acquainted with your risk tolerance. Your risk tolerance basically means how willing you are to lose money in the market. If you have a high tolerance for risk, you might be able to get better returns on your investments, but it also comes with the possibility of losing more of your capital.
Everyone needs to find a balance between the risks and rewards of investing. But you need to determine your own personal level of risk tolerance. Will you lose sleep if your portfolio’s value drops dramatically overnight? Or can you ride out the market downturn knowing that things will turn back up eventually?
While some people like to micro manage their investments, a buy and hold strategy typically works best for most people. This means potentially holding some investments as they lose value while you wait for them to regain value.
If you can’t handle watching your investments rise and fall in value – or if you can’t afford to lose money because you’re nearing retirement – select less risky investments. This is why experts recommend shifting your portfolio from stocks into more bonds as you near retirement age. You can never completely eliminate risk from your portfolio, but you can mitigate it.
Consider target-date investing. One way to remove your emotions from your retirement investments is to let someone else make the decisions. Robo advisors offer services that make decisions based on a risk tolerance quiz when you open your account.
Another option is to choose a target-date retirement fund from a traditional investment brokerage. Target-date funds automatically adjust your portfolio based on how long you have before retirement. The gradual shift from stocks to bonds occurs without any input from the investor, which can help you make solid investment choices while being fairly hands off.
Imagine your future. Finally, take time to imagine your future as a retiree. It’s easy to overspend in the moment rather than saving money for later. One way to combat this is to take time to envision your retirement and what you want it to look like. If you want to fulfill a dream of spending retirement on the beach, then you better start saving today.