4 Financial Mistakes Our Parents Made and How to Avoid Them
News flash, Starting Outers: Mom and Dad aren't always right. In fact, when it comes to personal finances, their generation has made plenty of mistakes. Here are some of the costly errors our parents might have made and what we can learn from their misfortunes.
See Also: 4 Financial Rookie Mistakes
1. They took on too much risk right before retirement.
At the end of 2007, nearly one in four investors between the ages of 56 and 65 still had more than 90% of their 401(k) accounts in stocks, according to the Employee Benefit Research Institute. That's far more than the 55% a typical target-date fund would hold in stocks for those on the cusp of retirement. As the market tumbled — Standard and Poor's 500-stock index lost 37% in 2008 — these investors saw their nest eggs get fried.
What you can do: Keep your portfolio properly diversified, and rebalance regularly. While you're young and far from retirement, you have time to take on all the risk you can stomach with your portfolio. And the market happens to be offering plenty of good deals (see How to Learn to Love Stocks Again).
But as you near retirement, you should ease up on risk, as our parents should have. To strike the right balance for my investments, my strategy is to stick with a target-date fund in my retirement portfolio. It maintains an age-appropriate mix of investments for me, adjusting as my retirement date draws closer, and prevents me from obsessing over day-to-day market gyrations. For more advice on maintaining a balanced portfolio and investing for the long haul, see Simple Investing Is Smart Investing.
2. They were overly dependent on one company.
Worse than neglecting to balance stocks and bonds: In 2007, nearly 19% of employees in their sixties held more than half of their retirement accounts in their own employers' stock. And almost 11% had more than 90% of their nest eggs tied up in their employers' stock. Think about that. If their employers' stock took a hit — as it likely did in 2008 — both their jobs and their portfolios could have vanished, just a few years from retirement.
What you can do: Again, you should make sure your investment portfolio is well diversified, not just with a good blend of stocks and bonds, but with an array of companies, industries and geographies, as well. Limit employer stock to no more than 10% of your 401(k) plan. Mutual funds, in general, are an easy way to invest in a number of companies at once. See the Kiplinger 25, the list of our favorite no-load mutual funds, and our picks for The Best Funds for Your 401(k) for some ideas.
3. They let you leech.
Among parents of 18- to 39-year-olds, 59% are still providing financial support to those who are no longer in school. And they’re bankrolling their adult children who are in school, too. Over the past 20 years, education spending by 45- to 54-year olds has increased 80%, according to the National Center for Policy Analysis. While some of those dollars have gone to midlife career training, the bulk of it went to you, dear student — and it took away from the money our parents could save for retirement.
What you can do: Teach your kids financial responsibility from a young age, so they're not counting on an allowance from you well into adulthood. Editor Janet Bodnar regularly offers her advice on raising Money Smart Kids, including Teaching Kids to Save, How to Handle Allowances and Preparing Kids for Credit Cards.
As for bankrolling your child's schooling, remember that education is optional, but old age is not. Prioritize saving for your own retirement ahead of financing your kid's education. Junior will have decades to pay off any necessary loans, but you won’t have nearly as much time to catch up on retirement savings. Bonus: Studies show that kids who put more money into their own college experience do better academically.
4. They underestimated how long they would live and what it would cost.
The good news is that our parents can look forward to reaching a ripe old age. The bad news is that they probably didn’t plan for it. Although life expectancy today is 78 years, only 56% of Americans feel financially fit to live to 75. In fact, 25% of people ages 46 to 64 have no retirement savings.
What you can do: Maybe Mom and Dad could take a lesson from you on this topic. According to a TD Ameritrade survey, Generation Y-ers started building their nest eggs in their mid to late twenties, while most non-retired baby-boomers waited until age 35. And nearly 56% of us make automatic contributions to our retirement accounts, compared with just 46% of their generation. We’re shedding debt faster than our parents, too.
So keep it up, Generation Y. Contribute at least enough to your 401(k) to earn all employer matching funds -- that’s free money. Aim to squirrel away 15% of your income into retirement funds. And don’t overlook savvy savings vehicles such as a Roth IRA; check out 8 Reasons You Need a Roth IRA Now.