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Retirement Investing Dilemma

Posted on May 2, 2012 by bobrichards

There's a terrible problem in retirement investing that concerns how much risk you should take with your retirement funds. It's a seemingly unsolvable financial conundrum of investing in retirement. Let's take a closer look.

On the one hand, you'd like to put all your retirement funds in the bank and keep it safe and secure in FDIC insured accounts. The issue is you will only earn earn 2% on your retirement funds. Let's say you have $500,000 of retirement investment capital. At 2%, the $500,000 would yield you $10,000 annually, not nearly enough for your living expenses. You do some calculations and find out that you would need to also use principal and at the rate you would need to do so, you would exhaust your retirement savings and die broke. On the other hand, you learn about investments that pay 8%. At 8%, the $40,000 a year generated interest income would allow you to not touch your principal. However, the 8% investments carry some risk to your principal. So here's your retirement investing decision: do you keep your money safe in bank accounts with the absolute certainty that you will run out of money and die destitute or do you take the chance of investing for higher returns knowing that it's possible your retirement money might get impaired. When phrased this way, the retirement investing decisions seems to clear up because the former choice is a foregone conclusion of failure while investing for the higher returns may in fact turn out well.  The latter choice gives you some probability of retirement investing success.

This is an insidious retirement investing problem because the correct solution is counter-intuitive. Let's pretend you are rich and you have $6 million of retirement funds. With $6 million, you can invest your cash in the bank and earn 2% and have $120,000 of yearly income -- more than you need.  But as we see in the real situation above, you have $500,000 and  cannot live on 2% interest, or $10,000 annually. You have no choice but to take more risk to earn more.  If you don't invest for higher returns, your funds will run out before you do.  If you invest for higher returns, even though you take on more risk, you at least give yourself a fighting chance of having your money last through your retirement years.  So the paradox is that rich people can invest more conservatively.

We often think of rich people as being able to take more risk.  In fact, rich people don't need to take more risk as they can tolerate low returns on large amounts of retirement savings.  It is those with less robust financial resources who have no choice but to invest more aggressively if they have any hope of having their retirement savings last.

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To see the proof of this, please look up the Trinity Study.  Without boring you of the technical details, I will supply a summary.

That study by university professors looked at retirement investment portfolios over long periods of time. The most conservative investors who kept 100% of their money in government bonds and withdrew 4% of the principal annually, exhausted their principal in 100% of the cases over all 30-year periods measured (let's assume that 30 years is the potential time that one spends in retirement). However, those that invested 100% in stocks and made the same 4% annual withdrawals, exhausted their principal in only 2% of the cases and met with success (they died with money to spare) in 98% of the cases.  So those that accepted more risk with their retirement investment selections (stocks over bonds) fared far better.

The lesson: if you are of modest means with a modest portfolio, erring on the side of caution is your major retirement investing mistake.

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    Filed Under: Retirement Investing

    About bobrichards

    Bob Richards
    Editor | Involved in Various Marketing Positions within the Financial Services Industry

    Comments

    1. John Hunter says

      May 25, 2011 at 12:26 pm

      I agree that it is a mistake to believe that a portfolio that hold individual investments that are more conservative for a long period of time is the safest portfolio. A portfolio over the long term that doesn't have balanced risk in some investment, is weaker than one that has some riskier individual investments.

      Reply
    2. jibran says

      May 25, 2011 at 3:10 pm

      it is really an important decision to invest your retirement fun because it is the saving of your whole life

      Reply
    3. James Ranch says

      May 26, 2011 at 1:53 pm

      Another important thing to think about is age.

      age + wealth = risk acceptance

      risk acceptance = asset allocation.

      That's how we should think through financial matters

      Reply
    4. Clement says

      May 27, 2011 at 9:09 am

      Retirement planning, I've opened an account with a insurance bank which includes life and saving plan... not quite sure how's the return yet but if you have a bunch of cash, i'll say put them into fixed deposit and just use the interest every month... what do you think? as fixed deposit have 0% risk comparing to any other investment although other investment have higher return.

      Reply
    5. Derra Huxley says

      May 30, 2011 at 2:02 am

      Very counter intuitive and fascinating that the assumption of some balanced risk yields better results for retirees. As you said, dilemma solved!

      Reply
    6. Vancouver SEO Services says

      May 30, 2011 at 8:39 am

      It's very important on how to invest your retirement benefits because this is lifetime already.

      Reply
    7. remove my mugshot from Google says

      June 1, 2011 at 12:43 am

      This is great. A big help of information to all especially for those person who wanted to know different retirement plan around the globe. Such a great and brilliant idea. Anyway, thank you for the post, I'll share this to my friends too.

      Reply
    8. ascentive says

      June 4, 2011 at 3:00 am

      Great summary of the influential Trinity Study. Although first published in 1998, there have been updates, the most recent of which was released in 2009. If people want to check out the original study, here is a link: http://www.aaii.com/journal/article/retirement-savings-choosing-a-withdrawal-rate-that-is-sustainable?utm_source=sitesearch&utm_medium=click

      Reply
    9. Glenebay says

      June 6, 2011 at 2:51 am

      Complicated topic. I agree all the comment above. Speaking of Retirement Planning, in a financial context, refers to the allocation of finances for retirement. This normally means the setting aside of money or other assets to obtain a steady income at retirement. The goal of retirement planning is to achieve financial independence, so that the need to be gainfully employed is optional rather than a necessity.

      Reply
    10. J @ Your Own Retirement says

      June 7, 2011 at 4:05 pm

      I think what it comes down to is taking a risk with your investing but a calculated one. Being too conservative will allow your retirement fund to simply not grow enough to provide you with a comfortable retirement.

      Reply
    11. Scott says

      June 8, 2011 at 7:02 pm

      I would go with high-dividend paying large cap stocks.

      Reply
    12. Michelle says

      June 8, 2011 at 9:57 pm

      I feel that the most important thing is to do your research and make sure you understand completely anything that anyone puts in front of you. People who get scammed didn't do their research and they paid the price. Now, not everyone needs to be a financial genius, but you can educate yourself to know when something is "too good to be true"

      Reply
    13. resume writers perth says

      June 10, 2011 at 9:12 am

      Retirement funds would be your last resource upon your retirement, so spend it wise, invest only on a business that you know.

      Reply
    14. Steve says

      June 12, 2011 at 9:41 pm

      I think the best way to invest is through fixed income vehicles like good bonds but the interest rates are so low.

      Reply
    15. Mike says

      June 18, 2011 at 4:20 am

      Retirement is never a subject of simplicity. I for one have been in a rush shoveling money into to my 401k and roth IRA so i can retire on time.

      Reply
    16. cheap whiteboards says

      June 19, 2011 at 6:51 pm

      I personally like to take the risk when investing. I go for the medium to high risk stocks and bonds because I feel that it's best "to do it and do it right". I also keep a fraction of my total investment in saving bonds so that I know that I have money to fall on in case something major happens to my portfolio.

      Reply
    17. anakart says

      June 20, 2011 at 2:56 pm

      It’s very important on how to invest your retirement benefits because this is lifetime already.

      Reply
    18. electricians leeds says

      June 30, 2011 at 11:46 am

      I go for the medium to high risk stocks and bonds because I feel that it’s best “to do it and do it right”. I also keep a fraction of my total investment in saving bonds so that I know that I have money to fall on in case something major happens to my portfolio.

      Reply
    19. similarsites says

      July 3, 2011 at 9:26 am

      There are a lot of risks that are taken involving this retirement, and as you said, 4% is not enough at all.

      Reply
    20. premium wordpress templates says

      July 7, 2011 at 7:03 am

      This problem should be solved immediately because many of our senior citizen are depending on their retirement fund. The government should act terrible and faster as they can. And it a good news also that these problem has been brought out early before it became worst.

      Reply
    21. Eric says

      July 7, 2011 at 5:57 pm

      Interesting analysis. Balancing risk in investments is not a problem specific to retirees, though it's certainly more critical in that case. Living Simply requires simple solutions, but thse can be fienishly difficult to come by. Unfortunately, the stock market has been very unreliable in recent years -- mostly a trading market for at least months. What to do if you have a finite amount of money and all invested in the stock market?

      Reply
    22. Tracy Banks says

      July 15, 2011 at 6:38 pm

      I would have to agree with this statement: This is an insidious retirement investing problem because the correct solution is counter-intuitive. You must start out saving when you are young so you can retire on time, and be smart about your investments.

      Reply
    23. punz says

      July 16, 2011 at 10:13 am

      I prefer safe investment in bank even it has low interest, because what, there isnt a certain future, all we can do is doing it with low risk

      Reply
    24. HealthyNews9 says

      July 24, 2011 at 1:22 am

      it is really an important decision to invest your retirement fun because it is the saving of your whole life

      Reply
    25. grand rapids banks says

      August 24, 2011 at 5:27 pm

      it is really an important decision to invest your retirement fun because it is the saving of your whole life

      Reply
    26. Alex says

      September 21, 2011 at 4:52 pm

      It is indeed an important topic. Everyone is supposed to live a happy life after retirement. But, as long as there is health....

      Reply
    27. Aji says

      April 13, 2012 at 11:14 am

      It's global problems for many people closed retire.But many ways to solve the problems

      Reply
    28. Andrew says

      April 16, 2012 at 9:09 am

      I'd go for business investment such as franchising or home business.

      Reply
    29. home loans says

      May 19, 2012 at 12:45 pm

      Age is only a number, a cipher for the records. A man can't retire his experience. He must use it.

      Reply
    30. credit cards says

      May 19, 2012 at 12:49 pm

      When you retire, think and act as if you were still working; when you're still working, think and act a bit as if you were already retired.

      Reply
    31. Bifolding Doors says

      June 7, 2012 at 12:52 am

      After planning to have a retirement it is really important to invest first so that the income will stay and may have the source of money to buy such personal needs or basic needs.

      Reply
    32. J [email protected] Payday Loans Companies says

      July 3, 2012 at 9:40 am

      Retirement planning is a necessary element during peak earnings, normally at 40s and 50s. It keeps retirement life fun and tension free.

      Reply
    33. Jackofdiamonds says

      July 12, 2012 at 1:43 pm

      IF we had all started investing as soon as we could learn to count we would be able to save up enough for retirement. However, youth is uninterested in the future and we end up suffering for it. I am now nearing 40 and had all my investments wiped out in 2008. But I still lead a happy life. Remember, whatever we do, the final destination is the same.

      Reply
    34. Investing says

      October 27, 2012 at 6:27 pm

      While it's true that a person's age and net worth are key factors in determining how much/little risk a retirement portfolio should contain, I believe the most important factor is the risk tolerance of the investor.

      If the risk profile of the portfolio doesn't match the risk profile of the investor, they are unlikely to stay the course with their retirement plan.

      Reply
    35. wedding photographer in dubai says

      November 8, 2012 at 8:45 am

      we must ensure that at what place we are investing,so that it remain retrieved our profits.

      Reply
    36. kimenim says

      November 13, 2012 at 11:03 pm

      Thanks for the information.

      Reply
    37. pjrockz says

      November 16, 2012 at 12:41 pm

      I had like to create an account with a insurance which includes save life & plan....not quite sure how's the return yet but if u have a bunch of cash, I'll say put them into fixed deposit and just use the interest every month... what do you think?

      Reply
    38. pjrockz says

      November 16, 2012 at 12:47 pm

      After planning to have a retirement it is really important to invest first so that the income will stay and may have the source of money to buy such personal needs or basic needs after planning to have a retiremen.

      Reply
    39. pjrockz says

      November 16, 2012 at 1:02 pm

      Retirement planning is make your life easy tension free when you are 45 years old. Everybody should to create a life insurance for myself. thanks to author to write this type of important things of human life.

      Reply
    40. Kevin Marshall says

      November 16, 2012 at 7:20 am

      Thanks for sharing this informative post , keep sharing like this !

      Article Writing

      Reply
    41. Joe LaMarr says

      November 26, 2012 at 12:55 am

      Great post thanks for the info!

      Reply
    42. james says

      December 8, 2012 at 7:56 am

      Great Post....nice concept.It is indeed an important topic. Everyone is supposed to live a happy life after retirement.We are new online bidding service where investors can login and bid on Foreclosure Real Estate Properties in Arizona going to auction every day. Here you are guided for Real estate investment fund foreclosures REO services.

      Reply
    43. xahid says

      January 6, 2013 at 5:36 pm

      I think a retirement need to have an objective... So before that we need to make some plan about it...

      Reply
    44. Anthony Smrke says

      January 7, 2013 at 8:44 pm

      As the Broker of Record for Milestone Silver Realty Ltd. ; I am always interested in what other Real Estate practitioners and those in related industries have to say and what they are doing with their blogs and websites. Retirement issues are of particular importance to me. Just thought I'd let you know that I came across your site and enjoyed the time that I spent there. As we all can appreciate: what we do continues to be “High Paying Hard Work and Low Paying Easy Work” Thanks for posting and thanks for allowing me to comment. Keep up the fine work.

      Reply

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