Understanding Investing For Retirement

by: Dividend Earner

Over the past few years of blogging, I have been discovering many views on investing regarding its purpose for investors. Most people invest for retirement and some invest for other reasons but what is consistent amongst all goals is that the more, the better. The higher the return on the portfolio value, the better and it often leads to discussions, or arguments, on which investing strategy is better.

Unfortunately, while it’s nice to have the best return, not all retirement plans are equal when it comes to the overall portfolio value. The accounts where the money is in for tax purposes have a lot to do with the benefits in retirement. In fact, you could find many scenarios where the following is true:

Portfolio A is bigger then portfolio B but portfolio B has better retirement income than Portfolio A in retirement. Taxes on the money is what makes the difference along with the reduction in investment.

Understand Your Retirement

How you plan to manage your money in retirement should play a factor in how you invest. Most people start investing when they are young and they are told they have time on their side and all… Most young investors will choose risky plans because of time… However, when you look at investing, it’s a road map with clear changes within specific time frames. Would you hold the same investments in retirement than you would when you were 20? If not, then you acknowledge that your investing strategy will change and do you really understand those changes and the long term impact on your portfolio during your 30+ years of retirement?

Portfolio States

There are 2 portfolio states and therefore 2 potential investing strategies.

  • Wealth Accumulation: this starts early and usually last for 40 or so years. In this state, you are focused on growing your nest egg. You fill the coffers to reach your retirement target based on many unknowns.
  • Wealth Reliance: Once you reach retirement, you must rely on the wealth you accumulated to pay the bills as you probably do not work. In this state, you use money generated from your portfolio or you make withdrawals. There can always be the question of whether or not you and/or your spouse will outlive the money.

For some generations, the wealth reliance was simply a pension plan. Nowadays, many have to invest and plan that stage. It can be quite a challenge.

Investing Roadmap

  1. Start young and put your money at work – put compound growth to work
  2. Save for a home – is that worth investing the money?
  3. Focus on retirement savings – balancing all the spending with family …
  4. Pay the home – that’s what we are told to do… I have since changed my focus with low interest rates
  5. Think about retirement – how will you use the money? which account? when?

As you can see, none of the steps have an investing strategy in mind but rather a long term focus, a long-term goal to work towards. Retirement being the last of all goals as you want to be able to live without the need to work as you may not be able to. Even if you can, you might not even want to work anymore.

With retirement, we are taught that the more money you have the better you are going to be. Except that a pension plan doesn’t work like that and they are often considered the golden retirement plan. Why not try to emulate a pension plan with your retirement portfolio? Pensions are far better in some cases as you are guaranteed an income which can be much easier than figuring out how long you will live and how much you can withdraw. An annuity could be used here but that’s putting your faith in someone else, I much prefer to focus on income generation from my invested capital.

This is what I believe investors need to think about; where is the money coming from and how much will you need.

Retirement is a timeframe in the investing journey. You need to think about it and have an idea about how you would go about it. I am fortunate enough to have parents who have to go through this stage without any old school pension plans. They are fully invested in the stock markets at 75 years old and living from the income. The perspective and learnings I can have from their experience is immense as many only see their parents getting pension so they are left to learning it all on their own.

Retirement planning is a challenge to teach as it can be complex when it comes to taxes and forecasting of portfolio growth. Everything is based on assumptions and the assumptions need to be monitored regularly based on the return of the retirement portfolio and the expenses expected. Every generations go through different challenges so it’s important to adjust and not become complacent.

My strategy with dividend investing is to emulate a pension plan where my portfolio generates the income I need after tax while never ever touching the principal. Based on that approach, my goal is to generate sufficient income with growth to keep up with inflation rather than build the best performing portfolio of the century or discussing the merit of index investing over other investing strategies. It is also foolish to think that an investor who has never learned about dividend or income investing can switch to that type of investing in retirement. The learnings and mistakes would take time and create a challenge at the moment when you need the money.

As a note, the 4% withdrawal rule is a guide to prevent you from running out of money… It has been recently discussed that it may not be accurate anymore due to the low interest rate environment we are in. I also question how much bonds one should have. Life expectency has changed over the past 30 years and I don’t believe you should have a bonds allocation that matches your age.

As you can see, you have a number of questions to answer to assess your retirement investing strategy or more specifically, your wealth reliance strategy:

  • Which account will your money be in? Tax free? Tax deferred?
  • What tax rate would you expect to be in? It does have an impact.
  • How much money do you expect to need? That amount of money has everything to do with how much your portfolio needs to provide.
  • When do you plan to retire? How long will you need to provide the retirement income for? Assume a good life expectancy.

The answer to many of those questions should help you figure out how you will invest. My advice, don’t settle on just one strategy, blend them if you can across your accounts.

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