I am 34 and I am pretty sure I will be working for another 3 decades out there, but what is wrong to think about retirement? Since I will not get any pension from my government, retirement is going to be interesting for me. I have to arrange my own income stream or source of regular cash flow. And this exactly where I started my research.
So, which portfolio is best for retirement investment? Since we are not the best at stock picking, probably it is not a great idea to keep all our eggs in one basket. Our retirement investments should consist, different asset class, such as equity, gold, income-producing real estate, even annuities. Focus solely on income-producing assets.
But, the very first question you need to answer is how much cash flow you would need every month when you are retired. You can focus on cutting down expenses, and the tax you pay is a huge expense, so if you move to a state with on state income tax will immediately save you some money.
You need to know your rent or mortgage payment amount, grocery expenses, medical expenses. I strongly recommend you read Tony Robbin’s “Unshakable” to understand how you can reduce expenses in retirement and how to calculate your expenses when you are retired.
Once you know how much money you will need, that is the milestone that you will need to shoot for. You will need to work to accumulate income-producing assets to hit that milestone.
What is a portfolio?
- The portfolio is nothing but a fancy terminology that essentially consists of the assets you have. You may not own anything, in that case, you do not have any portfolio yet. When you buy some stocks, a real estate, MLP, ETF, bonds, CDs, money market account, etc, all these go in your portfolio. Even if you own gold and silver, that would be part of the portfolio too.
- Billionaire hedge fund manager Ray Dalio talks about an all-weather portfolio, which is nothing but a well-diversified portfolio that works. Most businesses have cycles. Industries such as commodities or automotive are very cyclical in nature. Inflation and interest rates are historically cyclical in nature.
- Hence the concept of an all-weather portfolio that has all asset classes and that is built to survive all cycles.
- To give you a rough idea, keep 55 – 60% in your portfolio. 25 – 30% equity. Rest should be real estate and gold. But you will get a better breakdown in the book Unshakable.
How to plan retirement?
- Retirement planning is not easy. As a result, most people end up working well in their golden ages. Most American do not have enough saved for their retirement. For our generation, the biggest problem is going to be the life expectancy. With enough cash flow that actually might a good problem as long as we can keep ourselves healthy and happy.
- Why Life expectancy matters? Because you need to save up enough so that it lasts till your last day on this planet. If we outlive our savings that would be a good scenario.
- If you think about it we work 40 – 50 years at most and after retirement, we may live another 30 – 40 years without having a regular job, we need to save up enough income-producing asset that lasts for 40 years and the income should keep up with inflation.
- These are very basic facts we need to keep in mind, and then we need to figure out how much cash we would need every month. Then again, we will need to keep in mind that inflation will increase our expenses. For example, a 3% inflation, will double the cost of anything every 24 years. So if something cost $10 in the year 2019, it will cost $20 in the year 2043.
- SO, you need to outperform inflation that means you grow your capital and grow income from your portfolio. You need to buy assets keeping this in mind, and I think equity is a good instrument to beat inflation and the dividend can help you keep up with inflation too.
- A rental property can be a good inflation hedge too and as long as you can keep on increasing the rent every year the cash flow will help you keep up with the increasing cost of living.
Is Real Estate better than Stocks?
- First of all, I do not have any actual real estate or I am not a homeowner. I could never save up for a down payment and I move around a lot. But I have some exposure to real estate, via REITs. There are listed REITs and privet REITs. You can buy Tanger Outlet, Iron Mountain or Simon properties, these are all real estate investment trusts.
- What that means is these companies have to distribute 90% of cash flow to shareholders, you can buy these using Robinhood or Webull, that way you do not pay any commission on top of the price you pay. And you can buy private REIT using platforms like Fundrise.
- Other than that if you want to buy an investment property, you can check out Roofstock.com. Select a property that is in a good neighborhood, good school district, fairly new building that means built in the 2000s. You can buy and sell property on that platform, and you can rent the property out also, Roofstock will provide your property manager for a fee. Their charges are usually lower than realtors.
- So check them out. Here is a good critical review of Roofstock, and you give an idea of why real estate might not beat inflation, do watch it.
But that is just about the appreciation of the asset price, what about cash flow? If you can increase the rent every year, say around 5%, that offsets all expenses and tax increases, essentially helps you increase your cash flow by 2 – 3%, so that you can beat inflation, I would say that will be a good investment.
- Great businesses with low payout ratio give you the raise in the form of an increased dividend. And if the market is good and the company is seeing growth in earning, chances are the stock price will go up over the years and that means your capital will appreciate too.
If I want to explain the payout ratio simply, say free cash flow of a company XYZ inc. is $100. And, this company pays $50 out of this $100 as dividends to the shareholders. That means the payout ratio for this company is 50%. Rest 50%, this company can put back in business to grow the business. One more important factor is the interest coverage ratio.
Which tells us, how comfortable the company is to pay off its debt obligations. The higher the interest coverage ratio is, the better off the company is. Moreover, as a shareholder, a lower payout ratio and higher interest coverage ratio means, a higher chance of getting a raise in the dividend. And this will be great to beat inflation.
Can Dividend replace pension?
I would say yes dividend can replace pension income completely, provided the portfolio size is big enough. Let us take an example. Say you need $50000 a year post-retirement. Mainly because you have moved to Florida, the rent is low and you have calculated all your expenses, and you have concluded that you will need to produce $50000 in the first year. And probably you will need this $50000 income to go up by at least 3% every year to keep up with inflation.
On the second year, you will need $51,500
The third-year you will need $53,045
Fourth-year you will need $56,135 and so on.
Let us just focus on putting all your money in the S&P 500 index fund that gives you a 2% yield. IF you want to make $50,000 in dividend, you will need to invest at least $2,500,000 in that ETF. And it is a fairly safe investment, as 500 best businesses make this index fund.
The next year, your capital appreciated by 10% that means now your investment is worth $2,750,000 with a notional profit of $250000, you might get a dividend worth $55,000. And that means you will be able to keep up with inflation. But remember, this is a very optimistic scenario. And stocks do not go up all the time, in short term equity is very volatile.
There are other stocks, for example, Exxon, which gives you a 4.5% yield, that means if you buy Exxon stocks worth $1,000,000, you will make $45,000 in the dividend. So, the dividend yield is a huge factor in determining how much money you need to invest.
Before jumping on a screener and finding out all high yielding stocks, try to remember high yields are often not sustainable and most probably the stock price has fallen, pushing up the yield too high. The market thinks the company will not be able to continue paying a dividend. Any yield above 4-6% is considered too high. Always be mindful of payout ratio and interest coverage ratio.
I have a detailed post here about valuation and high dividend yield. You can read it to get a better understanding.
As long as you know how much money you will know every year, you can invest your money in income-producing stocks accordingly. Usually MLP, REITs. Utility stocks, commodity stocks can be a good stable source of dividends, although the capital appreciation might not be that great as all these are highly sensitive to interest rate, or business cycle sensitive.
What if you do not have enough to buy an investment property?
If you do not have enough cash to make a 20% down payment, your cash flow will significantly go down. Since the whole purpose of this investment is to generate cash flow. The rental income you generate, a significant amount will go towards making a mortgage payment. But there are other options to get started with. I would recommend REITs.
Go to fool.com and you will get good ideas, you can get good ideas on seeking alpha too. Make sure you research that REIT a bit. You need to know what might go wrong. The risk is not knowing, as long as you do your research you will be fine. The payout ratio is important for REITs too. If a REIT pays out 99% of cash flow than most probably it will not have any money left for growth. That means your dividend income from it might never grow.
Another option is fundrise, where I generate about 5%. I have supplemental income, there are 2 other choices that you can check out.
Best Investment for Retirement Funds
Most mutual funds have high fees. Keeping in mind that you want to compound your money as much possible. You should stick to low-cost S&P 500 index fund and that is what exactly Warren Buffet prescribes. Try looking up SPY on Robinhood. Robinhood is commission-free, so you save on commission too. Currently, this ETF is offering 1.8% dividend yield, which is pretax.
How to Invest Your Retirement
If you are in your 30s, then you have enough time to build a rainy day fund which you can keep in a money market account of in a saving account. That emergency fund should have enough money that you can survive on that for 6 months. For retirement, you need to plan for medical insurance too. As long as you have an emergency fund and all your medical expenses are covered, you can put rest of your money in equity.
But then talk to your financial advisor. Say, you get into an accident and you do not have enough money to cover all expenses if the market goes down at that moment that may leave you bankrupt or can cause significant damage to your portfolio. So it is best to leave a significant sum for an emergency. But then that part will barely keep up with inflation.
While you got some idea about what are the factors you need to consider, but still you can talk to a financial advisor, to find out how to address those concerns.
Have you started planning your retirement? Where are you putting your money? Did this post help you? Did you get any new idea? Please let me know.