Generating income for — and during — retirement can be a challenging endeavor. The most common mistakes people investing in their futures make are very simple: being too conservative or too risky in decision making. Despite today's tough economic environment, there are many ways to increase your retirement income, whether it's for the future or right now. (For more, see: How to Decode Your Future Retirement Income.)
On the conservative end of the spectrum, say a retiree has $1 million saved in 1990. That's a substantial amount of money, especially in 1990. A common theory is that someone with a large nest egg can simply live off interest and dividends by taking a very conservative approach to investing. This is possible, but it will usually require a lot more capital than $1 million. For example, if this retiree had invested in 10-year treasuries, then he or she would have earned $82,000 annually. However, in the year 2000, that annual return would have been just south of $67,000. By 2014, it would have been only $27,000.
This illustrates how important it is to reevaluate your portfolio and retirement strategies on an annual basis. Markets and interest rates can change fast and unexpectedly, and you don't want the value of your investments to dramatically depreciate because you haven't considered the impact of what's going on economically. (For more, see: How Should a Risk-Averse Investor Build a Retirement Portfolio and 10 Retirement Saving Myths that Won't Go Away.)
Finding a BalanceHaving a portfolio overweight in stocks may prove to be too risky. While investing in a big pile of stocks can be highly lucrative during bull runs—often found in low interest rate environments—a market crash could have devastating effects on your holdings. Balance is key, and balance should depend on the size of your nest egg and retirement goals, which can involve any of the following: global bonds, TIPS, mutual funds, corporate bonds, U.S. equities, emerging market equities, U.S. treasuries, high-yield bonds, ETFs, short-term bonds, intermediate bonds, foreign bonds, fixed annuities, CDs, CD ladder, large-cap/dividend-paying stocks, REITs, and more. (For more, see: My Retirement Portfolio: Penny Stocks or Large-Cap Stocks?)
That's a lot to choose from, and the pool of options makes retirement planning confusing and frustrating. It's also why it's a good idea to hire a financial advisor that you trust and feel comfortable with. If you don't feel compatible with the first advisor you meet with, move on to the next. (For more, see: Finding the Right Investment Advisor.)
Prior to hiring one, you want to establish an idea on a long-term game plan for retirement. Here are some ideas that can increase your income during retirement, as well as some information on how well different types of retirement portfolios have performed annually over the past 44 years.
Work a Little LongerThe most obvious and effective way to increase retirement income is to postpone retirement. As long as you're healthy, this makes a great deal of sense. It might be tempting to retire a few years early, but it's going to cost you down the road.
You can start collecting social security at 62, but if you retire at an age between 65 and 67, then you will receive 20% to 30% more annually than you would at 62. Instead of investing capital, you're investing time in order to receive higher returns in the future. (For more, read: Understanding Social Security Eligibility and How Do I Calculate my Social Security Break-Even Age?)
You can start collecting social security as late as 70. For every year you wait, your return will increase by 8% annually. If your full retirement age is 66 and you wait until 70 to retire, then your return will be 32% higher than it would have been at 66.
There are a lot of questions (and even doubts) about the sustainability of social security. The government has accumulated too much debt to be able to fully fund this program in the future. However, if you're reading this, then social security should remain in existence (at least partially) by the time you retire, and if not, it will likely be reformed somehow. It's the millennials and younger generations who have the most to worry about when it comes to social security.
Lastly, by working longer, you will not only be postponing social security and pulling in higher returns, you will be adding to those returns by contributing through traditional work. (For more, read: How Should I Invest the Money I Keep on my IRA?)
Another option is to consider working part-time when you're retired. Then you'd be accomplishing two goals. One, you're adding to your retirement nest egg. Two, you're reducing your withdrawals, which you'd be dipping into if you weren't working. This is the same thing as a company improving its top-line and bottom-line simultaneously, and that's good business.
Unless you have money to burn, downsizing your lifestyle will help increase your savings. For instance, if you live with a significant other in a house that used to include two children, then despite any nostalgic attachments, moving into a smaller home or a condominium presents an opportunity to add substantial capital to your nest egg. You will also free up money for traveling, dining out, boating, or whatever hobbies you enjoy. (For more ways to strategize your retirement, see: Retirement Planning Tips for Singles.)
How, Where to InvestIn spring of 2015, the federal funds rate — the interest rate at which depository institutions trade balances held at the Federal Reserve with each other — was at historic lows and has remained that way for years. This has led to savers being punished and speculators being rewarded. It's not fair to retirees, but the good news is that it's not sustainable. One place that many investors figure is safe from market fluctuations is the bond market. But the bond boom that's been mounting over the past 30 years may be coming to an end. Today it's all about selectivity: With debt-fueled growth happening across many industries, defaults are going to increase over the next several years. If the stock market is also at risk, where does an investor turn? (For a look into how others invest, see: How the Ultra-Wealthy Invest.)
Invest in yourself. If you're still working, experts recommend that you cut expenses so you can save 10% of every paycheck. This won't earn much interest since the money gets wired directly into a savings account, but adding interest isn't the goal. Instead, you're guaranteeing a 10% annual return, which any sane investor would be happy with, especially in the current economic environment. This savings will allow you to sleep well without having to worry about stock and bond markets. There's another benefit as well. When the markets correct themselves and all the junk is washed away, you will have an opportunity to invest in quality at discounted prices.
If you're going to invest in bonds and you're risk-averse, then consider looking into a short-term bond fund, which offers diversification and mitigates the risk interest rate changes. (For more, see: Time to Buy Floating Rate Bonds?)
Avoid the TrapsSome retirees are obsessed with having an enormous income, but this often leads to high-risk investments in stocks. While you need some type of income in retirement, the last thing you want to see is losses due to reckless decisions. Instead of focusing on maximizing income and performance vs. the S&P 500, focus only on the amount of income required to maintain your lifestyle — or the downsized one you're aiming to have later in life.
High-yield stocks can be dangerous, too. Oftentimes, they aren't sustainable. You have to wonder why the company is offering such a high yield in the first place. Is it a firm that's no longer capable of delivering organic growth? Is it taking on too much debt in order to fund these dividend payments? Researching every angle of every investment strategy you're considering is a must.
If you're going to invest in an annuity, make sure it's a fixed annuity so you avoid any potential hidden fees. Also make sure it's offered by a highly-rated insurance company and that it comes with an inflation rider. (For more, see: Longevity Annuities Arrive in 401(k) Plans.)
The following numbers come from the Charles Schwab Retirement Calculator. They're all based on the years 1970-2014. The information provided should give you a general idea of what returns are like based on risk tolerance, but also keep in mind that the next 44 years will likely look a lot different than the past 44 years. (All performance numbers are annual.)
Investment Strategy
Stocks
Fixed
Cash
Average Return
Best Year
Worst Year
Aggressive
95%
N/A
5%
10.3%
39.9%
-36%
Moderately Aggressive
80%
15%
5%
10.1%
34.4%
-29.5%
Moderate
60%
35%
5%
9.7%
30.9%
-20.9%
Moderately Conservative
40%
50%
10%
9.0%
27.0%
-12.5%
Low Risk
20%
50%
30%
7.8%
22.8%
-4.6%
The Bottom LineIf you want to increase income in retirement, consider postponing retirement, working part-time during retirement, and/or downsizing your lifestyle. Prior to retiring, choose a financial advisor that you trust and feel comfortable with. Prepare a strategy that will allow you to live comfortably without taking on too much risk, and be sure to reconvene annually to collaborate on any future strategies based on changing economic conditions. (For more, see: Top Commodities ETFs for Your Retirement Portfolio.)