4 mistakes older Americans make

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Making prudent financial decisions for retirement is fraught with difficulties. And yet, despite that knowledge, retirees and preretirees continue to behave the same way when it comes to money -— they continue to make the same mistakes and decisions that put them in harm's way.

Or at least so say academicians, researchers and authors who were among those that gathered at a conference at Boston University to discuss the future of what's called "life-cycle" investing and saving. What are some of those mistakes and, more importantly, how can they be avoided? Here are the four biggest errors older Americans make:

1. Putting more of their money into risky assets than is prudent

You don't have to be old to make this mistake, says Dallas Salisbury, the president and CEO of the Employee Benefit Research Institute. Indeed, people of all ages put money into risky assets that they can't afford to lose and then panic when they suffer paper losses.

But for older Americans who have stopped working and who don't have enough money set aside, the mistake of putting too much money into risky assets is even bigger. Inadequate assets become even more inadequate when the market tanks, he says.

David Laibson, a Harvard University professor, says older Americans should put some money into risky assets. The trick, however, is to find the appropriate asset allocation. Laibson, for instance, said in an e-mail that Americans tend to "underdiversify" their assets, putting too much money into their employer's stock, and too little into bonds and foreign stocks. Plus, they tend not to put enough into stocks, or what some are now calling risky assets.

Too much, too little. Who's right? Neither and both. The amount older Americans should put in stocks/risky assets depends not on rules of thumb but on good old number crunching. Says Salisbury: "There's an underemphasis of the fact that individual needs, circumstances, attitudes, behavioral patterns, loss aversion, health status and job attractiveness should be taken into consideration on a one-by-one basis."

Salisbury also says one innovation that might help people better understand the nature of risky assets and the amount one should invest in stocks is this: "Market-shock analysis and projections that incorporate risk and projections that assume 'worst-period returns,' as well as 'historical-smoothed returns,' so that the individual can absorb all potentials and make fully informed decisions." In fact, he said projections about performance should be presented more like the way actuaries present things. They give a 'pessimistic, intermediate and optimistic' projection.

Salisbury is of the mindset that advisers tend to overemphasize past performance as "if patterns will repeat regardless of the degree to which globalization, demographics, taxes and stage of economic development have changed relative to the past and will continue to change in the future."

2. Overspending

Older Americans who have stopped working and who "know" they won't live long or who don't understand actual life expectancies are likely overspending, says Salisbury. Ditto those older Americans who have stopped working and who used historical average rates of return to project what their nest egg will be worth. Those folks made the mistake of not calculating what the impact of a one-time major market shock might be on their ability to spend.

A growing number of experts today are using Monte Carlo simulations to project the probability of a portfolio lasting a lifetime or not. The calculators at ChooseToSave.org can help Americans get a handle on savings, retirement expenses and longevity, said Salisbury.

Assume you live to the "long-end of the tail" of whatever the longevity calculator tells you, he said. Also, do not stop working and saving until you have enough money under the pessimistic line for your investment allocation.

3. Not owning enough insurance

Given all that could and does go wrong in retirement, Salisbury also says older Americans should buy more property, life, auto, disability, health and long-term care insurance. Self-insurance, says Salisbury, is a sure way to destroy your savings. Likewise, Laibson said Americans are not setting aside enough to pay for potential late-in-life health and long-term-care costs.

4. Not having enough inflation-indexed guaranteed income

According to Salisbury, many older Americans need to cover their basic living expenses with guaranteed, inflation-indexed sources of income. Time was when Americans had both a traditional defined benefit plan and Social Security. Now, he says older Americans need to buy "inflation-indexed life income annuities" to make sure they have enough income no matter how long they live.

Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times and Mutual Fund Market News.

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