Best Investment Options for Retirement
What are the best investment options for retirement? What investments provide enough money to pay your bills and maintain your lifestyle even when inflation increases prices or the market goes down?
Most people work 40 years to build up a nest egg to retire on. Once retired, they start pulling money out of their accounts to pay for bills and life. An important question to ask is:
How much money can I spend each year without running out of money?
Many investments advisors recommends selling 4% of your nest egg each year to fund your expenses. They also advise to increase that over time to keep up with inflation. Inflation cause prices to go up, and it’s why the purchasing power of $100 ten years from now is less than it is today.
The perfect retirement investment strategy should do 5 things:
- Grow our wealth reliable over long periods of time (15+ years).
- Minimize the volatility of our portfolio.
- Generate reliable income to pay our bills.
- Income should grow at minimum the same rate as our bills.
- Easy to understand and follow.
The Typical Retirement Plan
Let’s use Tom and Jane for an example. They have worked their entire life and saved up $500,000 for retirement. They retire at the age of 62 and expect to collect $3000 each month combined from Social Security. They spend $56,000 each year to live a comfortable life and would like to continue with that lifestyle. There is a gap of $20,000 each year that is not covered by Social Security. Tom and Jane have to cover that themselves without a paycheck and withdraw it from their nest egg. It is only a matter of time until they run out of money.
Let’s look at some investment options for retirement.
The Best Investment Options for Retirement
Investing in Mutual Funds for Retirement
If Tom and Jane are to invest the $500,000 into the stock market, and place it in mutual funds, they can expect an average yearly return of 9%. Some may say that is conservative and you can get more, while others think that is very good. But let’s use 9% for the sake of this example.
Four percent of the $500,000 is $20,000, which is the exact amount they need to cover each year.If they Tom and Jane withdraw 4% each year, they can continue to live comfortably and their nest egg will continue to grow. A 9% return of $500,000 is $45,000 which in total increased their investments.. As inflation increase the cost of living, they can increase the amount they take out
That is a very common way to invest for retirement, and many investment advisors will recommend to put it in mutual funds. It makes a lot of sense, it works great when the market grows. But what are the risks, and
What if the stock market goes down during their first year of retirement? Say their mutual funds drops 9% instead of growing. Now they are down to $435,000 after taking out their money to live on.
What if the recessions continues and their investments drops almost 12% during year 2? Now they are down another another $51,000 but they still got bills to pay so they withdraw $20,000 when the market is down. At the end of the year their investments are less than $363,000
At year 3, the market hits the bottom of the recession and Tom and Jane’s portfolio is down an additional 22%, with a value of $261,000. Almost a 50% loss from when they started. It does not feel good to withdraw anymore money, and it doesn’t feel good to be in the stock market. Many jump ship after a beating like that.
Are mutual funds the best investment option for retirement? Can you afford to retire during a recession?
Investing in Bonds for Retirement
A ten year US treasury bond for $10,000 bond with a 2,5% interests rate will pay you $250 per year in interest. And after 10 years you get your $10,000 back.
Mary and Sam saw how Tom and Jane’s retirement investment was cut in half during the recession, so they decided to invest their retirement savings in bonds instead. That is much safer with a guaranteed return, you know exactly what you get when you buy it.
They invest their entire $500,000 into corporate bonds paying 4% interest, which gives them $20,000 per year in interest payments. And they don’t have to worry about the stock market cleaning them out like it did to their friends. It feels safe.
However, they have a huge problem and it’s called inflation. Prices on groceries, electricity and every other expense go up every year. But their interest payment stays the same. So their purchasing power gets lower and lower for each year.
With an inflation of only 3%, it takes 25 years for your $1 today to be worth $0.5 then. Bonds are not a wise choice to invest in for retirement.
Investing in Dividend Growth Stocks for Retirement
This leads us to our favorite investment option to retire on, dividend growth investing.
Dividend growth stocks tend to outperform the S&P 500, something most mutual funds fail to do. They are also less risky as they fall less than index funds during recessions. In 2008 when the markets fell significantly, the S&P 500 index fell by 37% while a basket of dividend growth stocks only fell half of that.
$1 million invested in dividend growth stocks with a dividend yield of only 3% will pay you $30,000 a year in dividends. That is without selling a single stock and regardless if the market goes up or down.
Dividend growth stocks increase their dividend their dividend each year. I personally only invest in stocks that grow their dividend at least 6% each year, while some stocks grow their dividend more than 20% each year. The dividend pay increase is far better than the 3% inflation that other investment options battle.
Other Investment Options for Retirement
What other investment options for retirement do we have?
- Annuities. Sounds good on paper but too complex, do not account for inflation and carries too much risk. An annuity contract can come with a 2000 page contract / terms, and I have yet to meet a financial adviser who understand those terms and are capable of explaining them. The insurance / issuing company takes your money and invests them in bonds and stocks, and pays you your monthly annuity. If they go bankrupt, all your savings are lost and you will not receive any more annuity from them.
Invest in dividend growth stocks. It is the only option that fits all the requirements we set when investing for retirement.
You are not vulnerable if the market goes down as dividends are still payed and you won’t have to sell any stocks to pay your bills. The dividend also grows faster than inflation, so you don’t have to worry about prices going up and everything getting more expensive. It is also easy to understand. The companies makes a good profit, and pays part of that profit to the shareholders, the owners of the company.