The Real Truth About Retirement Investing
You’ve worked hard your entire life, setting aside money regularly to invest so that when the times comes for you to retire you’ll be set for life. If you started at a young enough age and invested wisely, you may even have amassed a considerable amount of money.
Since many people will be in the workforce for at least forty years (and few will have pension funds), many experts have historically recommended directing a portion of the income earned into some sort of investment account. The idea is that once you retire, you use the money from your investments, along with social security benefits to live on.
In theory this is a wonderful plan and if it actually worked, it would be even better. But like most things that sound almost too good to be true, there is a flaw in this theory. The flaw is serious enough that it may force you to rethink your retirement plans.
What happens is that the dream of filling your days with fun things like travel, golf, eating out, shopping and spoiling your grandkids often falls flat when you realize that all that stuff costs money. And since you’re retired you don’t have as much income as you did when you were working, so you can’t afford to do as many of those things as you’d like to.
Two Kinds Of Income
What’s going on? Well, the problem stems from the fact that there are two kinds of income – active income and passive income. Active income is the kind you get when you’re working, either as an employee or from running your own business. Passive income is the income you get from investments, pension plans and social security.
Active income is a lot easier to increase than passive income. If you want more active income, you work more. But earning more passive income is a lot harder because you have to be able to get a higher rate of return (or interest) from your investments or hope for a raise in social security or pension benefits. (I wouldn’t hold my breath for that to happen anytime soon.)
It’s a slippery slope because when you retire you want the security of a stable income so your financial advisor will recommend that you stay away from high-risk, high-reward types of investments. But more stable sources of investment income have a lower rate of interest because it’s guaranteed.
Possible Investment Scenarios
You’d be amazed at how much money you need to have in your investment account just to maintain your current standard of living, strictly with passive income. Think about how much money you and your spouse are taking home currently, and then eliminate only the money you divert to savings and you’ll have a good ballpark figure. Once you’ve done that you’ll want to try to figure out how you are going to generate close to that in passive income.
For example, if you thought that $50,000 a year would be enough, then here are a few different investment scenarios for you to think about that would earn that amount annually.
If you had all your money in a plain old savings account, you’d need to have around $5,000,000.00 (five million bucks) sitting there because the average savings account today only pays out 1% (or less) in interest.
If you invested in slightly more risky municipal bonds, you’d probably be able to get a return of about 4% on your money. At this rate of interest, you’d need an initial $1.25 million to generate that $50,000 annually.
(And these are getting even more risky as more cities, like Detroit, are opting to go bankrupt and are defaulting on their bonds.)
If you decided to play the stock market and your goal was to earn 12% each and every year, you’d still need to start with around $420,000. But the stock markets are very volatile so to earn this much return on your investment, you’re also be running the very real risk of losing your money.
There are no guarantees with stocks, except that you will constantly be checking on and worrying about how well or how poorly your stocks are performing. Definitely not a recipe for a relaxing retirement.
Statistically, the goal of the average American middle-class couple is to retire with between $250,000 and $300,000 in investments. That sounds like a lot of money until you do the math and realize that it’s not going to be nearly enough. (See our article “Retiring – Why Even a Million Dollars May Not Be Enough)
What Living on Less Might Mean
Now, you could certainly retire and live on less. But is that what you truly want to do? That really depends on how you’d like to spend your retirement years and on the kind of lifestyle you’re used to living.
Let’s face it. It’s not going to be any fun to stay home every night, if you’ve been looking forward to going out to dinner and a movie with friends a few times a week.
If you enjoy shopping, a lower retirement income is almost certainly going to put a severe crimp in your excursions, no matter how much of a bargain hunter you may be. If you’ve always belonged to the local golf club, will you still be able to afford the annual fees, let alone the green fees? Well you get the idea.
What’s The Solution?
So where’s the happy medium? It all goes back to the fact that you can earn more from active income than you can passive income. But that doesn’t mean that you have to give up the retirement dream. Instead why not do both?
Working when you’re retired can be better than it was when you had to hold down a job. That’s because you can do something that you enjoy or that you find meaningful because you’re only trying to supplement your income, not replace it.
You may want to find a way to earn some money by working at home instead of getting a regular job. It could be the perfect opportunity to open a small business of some kind. The Internet has opened up a whole realm of new possibilities too.
Including the option of earning ‘active’ income when you’re planning for your retirement can help you in a couple of ways.
First, in the event of an unexpected emergency or opportunity, you know you can generate extra income if you need or want to.
Second, it helps you make smarter investment decisions. (If you’re able to earn money to supplement your investment income, you won’t have to worry about investing in riskier options just because you need to earn a higher rate of interest on your investments.)
Whatever you decide, you might want to think of this active income as your “fun fund”. Use your passive income to pay the bills and use your active income for the extras that make life worth living. And then get on with the real “business” of enjoying your retirement.