Many people envision retirement as a time when they can sit back and relax after all of those years spent toiling in the workplace. They see themselves traveling to places they’ve always wanted to go, helping with the grandchildren’s education, and playing golf whenever they wish. Free at last!
Most of the dreams you may be having about your retirement have at least one thing in common: they require money. Your hard-earned savings needs to be carefully watched so you’ll never live out the nightmare many retirees have: outliving their money.
Your nest egg will need to continue growing long after you’ve stopped working and are enjoying your golden years. Hopefully, you’ve saved and invested wisely during your working years and had solid investment returns during the accumulation stage of your life.
Varying Rates of Return
The rate of return on investments is critical to investment success during all the stages of life. The observation that “The greater the risk – the greater the reward” has proven to be true over the nearly 100 years of investment return tracking done by the financial markets.
Someone who is in their early 20s is told by financial advisors and investment companies to invest in stocks to maximize their returns. Investing 100% in stocks is not uncommon at this point in life.
In contrast, someone in their mid-50s will be advised to have a more conservative, blended investment portfolio of both stocks and bonds. They must be looking to reduce their exposure to extreme fluctuations in the stock market and avoid suffering large losses before they retire.
Of all the age groups, retirees must be the most judicious when considering their investment portfolio. They can’t afford to suffer large investment account losses since they don’t have as many years of life left as younger investors do to recover those losses.
Determining Appropriate Investments During Retirement
The total amount of money available to invest during retirement and the retiree’s age are the strongest determinants of which investments retirees should include in their portfolio. These will determine their expected rate of return during retirement.
For example, a 65-year-old with $500,000 in their retirement account can be more aggressive with their investments considering their longer life expectancy than someone who is in their late 70s and has drawn down a similar account over the years to a balance of $250,000.
One analysis conducted by investment giant Vanguard perfectly illustrates how returns are affected by asset allocation. From data dating back to 1926, it was found that a portfolio of 70% stocks and 30% bonds grew at an annual average rate-of-return of 9.1%. A portfolio consisting of 50% stocks and 50% bonds grew at an average rate of 8.2%, and a portfolio with 20% stocks and 80% bonds produced an average annual return of 6.6%.
What Can You Expect?
As shown by the Vanguard study, your rate of return will vary greatly depending upon your risk tolerance. For example, if you’re a big believer in the future of technology, investing a portion of your portfolio in stocks such as Apple and Microsoft may be something you’re comfortable doing, as opposed to someone else that prefers the safety of government bonds or treasury bills over stocks. Historically, the stock investments will yield a higher profit.
It should be noted that there was a 2.50% difference in the annual rate of return between the portfolio with 70% invested in stocks versus the portfolio with 20% invested in stocks.
How significant is that difference over time? $100,000 invested for 10 years, earning a 2.50% annual rate of return, will have earned another $28,008 in interest. An investment of $500,000 would have earned an additional $140,042, which would make a significant difference in the retiree’s lifestyle.
Inflation and Taxes As Enemies
There is a dual threat to the accumulation of invested capital and the rate of return, and those threats are inflation and taxes. Any discussion on rates of return needs to take these threats into account because of the impact they have on the net amount of money you have left to spend each year.
A $10,000 profit on the sale of a stock you own does not mean an additional $10,000 in your pocket. Depending on your tax bracket and filing status, that profit could be subject to a capital gains tax of up to 20%, meaning you actually realized $8,000 in profit. You’d also lose an additional 3% to inflation each year, based on that being the average inflation rate for the past 80 years.
The Value of Peace-Of-Mind
While your expected rate of return during retirement should be of paramount importance to you as you do your financial planning for the future, choosing investments that you are comfortable with is of equal importance, if not more.
Stock mogul Warren Buffet said he never invests in businesses he doesn’t understand. You’ll want to make sure you fully understand what you’re investing in and what you can expect it to provide for your future. The value of investment performance can be measured, but peace-of-mind is invaluable when it comes to investing.