Today’s post is about the importance of investing for retirement, not saving for retirement.
Most retirement financial planning advice is about how you must accumulate a nest egg for your “golden years”.
For most people, this nest egg retirement fund needs to be at least $1 million if they want to have enough money to last them 30 years.
Advisors usually tell people that they can withdraw 4% of their retirement nest egg money each year, and that at a 4% withdrawal rate their money should last 30 years.
But here’s the problem with this advice: You’re depleting your retirement account by 4% each year. A few bad years in the stock market (like 2000-2002 or 2007-2009) and your $1 million account may drop to $500,000. You now won’t be able to withdraw 4% without running out of money earlier than you expected. The plan falls apart right when you need it to work….
In addition, trying to accumulate $1 million by retirement is a daunting task, and could take 30-40 years to accomplish. For many people this looks so impossible they don’t even try.
In my opinion, the best financial planning is really all about income planning. Everyone needs more income, whether now or in retirement.
In the end, this is what’s most important: it’s not how much money you accumulate, but how much passive income your money can generate. By passive income I mean income that comes in without you having to physically work for it.
Working to create an investment portfolio that can generate enough income to pay all your monthly bills is smarter and much more doable. It can also be done in much less time than is needed to accumulate $1 million.
To do this, you need to put together a portfolio of investments in stocks, bonds, real estate, tax liens, and other investments that will generate the passive income that you need, both now and for your retirement years.
I like to think of passive income as mailbox money – money that just shows up in your mailbox or bank account. Mailbox money is the key to financial freedom and independence.
The earlier you start to invest the better, because you can make use of time and compounding, which is simply reinvesting your investment gains into more investments. Done over a multi-decade span, you can slowly but surely grow a small sum into a large nest egg that generates significant income each month.
Time is the most important ingredient in compounding, so it’s important to start as soon as possible to let compounding work its magic.
People frequently confuse the concept of saving versus investing. Saving is not the same as investing. Saving is parking money in a bank, credit union, or similar account and receiving the interest rate that they pay you on your savings.
In recent years, most financial institutions have been paying depositors zero or close to zero on their savings. Unfortunately, you cannot become financially free or even get ahead by only saving your money; inflation alone will reduce the purchasing power of your money. You must learn how to invest it for a higher return.
That said, you should have some money parked in savings for emergencies. It’s recommended that you should hold enough money in savings to cover 6 to 12 months of expenses as a safety net.
This money should be put into a supersafe conservative vehicle like a savings account, money market fund, or a CD. It should not be invested in the stock market, bond market, or other market that significantly moves up or down.
Only once you have your emergency safety-net savings should you invest in stocks, bonds, real estate, or other investments.
To illustrate how different the outcomes are from saving vs. investing, let’s take a look at a scenario using a retirement calculator. I am going to use one I found at http://networthify.com.
In Scenario 1, I have used the example of someone earning $50,000 a year and who saves 10% of their income, or $5,000 a year. Their current annual expenses are $45,000. They receive a 1% return on their savings, the going rate today if you put money into a CD.
The result: By saving $5,000 at 1% each year, it will take 118.5 years to generate an annual income of $45,000.
I don’t know about you, but I don’t think anyone will live that long!
Here is the link to the calculator with these parameters already inputted:
In Scenario 2, I have used the same example of someone earning $50,000 a year and who saves 10% of their income, or $5,000 a year. Their current annual expenses are $45,000. They receive a 9% return on their savings, something that is currently possible by putting the money into dividend paying stocks and bonds, rental real estate, tax liens, and other investments.
The result: By investing $5,000 at 9% each year, it will take 35.5 years to generate an annual income of $45,000. By retirement, their investment account is generating $45,000 a year in income, which equals their expenses.
Here is the link to the calculator with these parameters already inputted:
So, while the results are not entirely real world, they are handy for seeing the results of different investing returns and for comparing saving vs. investing.
The higher the return you get on your money and the more money you can invest, the faster you will reach your income goals.
Saving your way to a secure retirement just doesn’t work. You just won’t be able to save enough to reach any kind of realistic retirement goal.
In the end, it’s not how much money you can accumulate before retirement. It’s how much passive income your money can generate – income that comes in without you having to physically work for it – that is important.
At a 1% return, you won’t live long enough to enjoy your money. At a 9% return, you can generate enough money to cover your retirement expenses forever. The key is to start early.
First, put away enough money so you have a rainy day emergency fund. Then start to invest any additional money apart from this emergency savings.
Remember, only by investing your money can you get ahead and move towards financial security and ultimately financial freedom and independence.
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Sheilish
Michael –
Great info you’ve put up here! I’m really enjoying getting familiar with the material you provide. Thank you for that!