Once you retire, your relationship with your money changes. After all, you’re no longer drawing a paycheck and instead likely need to use some of your money to cover your day to day costs of living. To deal with that change, you need a smart investment plan for your retirement money that enables you to meet several different goals:
· Have the money you need to spend available to you when you need it,
· Deal with the fact that the market does go down from time to time, and
· Deliver enough growth to help cover your long-term costs and fight inflation over time
These six ways to invest your retirement money can each help you meet one or more of those goals. No one investment is likely to meet all your needs, but a combination could help deliver your end to end plan.
How to invest your retirement money
How to invest your retirement money
1. Cash (and equivalents) is still king
You need money to pay your bills, and there’s a wonderful peace of mind that comes with having a little more than you strictly need so that you can handle any emergency costs that may arise. The advantage of holding cash is that you know exactly what it's worth at any given time, and it's immediately available to pay your costs as they come up.
The downsides of cash are that it tends to lose purchasing power to inflation over time and that once you spend it, it’s gone. As a result, while having some cash is critical in retirement, you also need to hold other investments in order to replenish that cash in the future.
The amount you should hold in cash -- or the equivalents like checking or savings accounts -- is somewhat a matter of personal preference. Still, something like two or three months' worth of living expenses, plus three to six months' worth for emergency purposes, should be enough cash to get you through.
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2. Certificates of deposit (CDs)
CDs offer a way to earn a little more interest on your money than you’d get in a typical checking or savings account. The downside, though, is that you usually have to pay a penalty if you want to withdraw your money before the CD matures. The returns generally aren’t stellar, and you’ll likely find that your CDs struggle to keep up with inflation and taxes over time.
As a result, a great use for CDs is to provide a short-term holding area for money you’ll need to replenish the cash you’re spending. For instance, if you set up a CD ladder with maturities ranging from a few months to a year or two out, you can use your maturing CDs to replenish the cash you’re spending in your everyday life.
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The promise of annuities is the potential for a higher immediate income than you could get on your own, combined with the possibility that the income will last for the rest of your life. Annuities may play a role in your retirement portfolio, but if you’re considering one, go into the transaction with your eyes wide open. Many annuities are incredibly complicated, with each additional potential feature coming at a cost that could make it less worthwhile overall.
The simplest annuity is one known as a “single premium immediate annuity” (SPIA). You hand the insurance company a lump sum of money, and it starts sending you a monthly check. These annuities are often the best overall from an investor’s perspective, as their straightforward nature makes them more competitive and transparent than their more complicated brethren.
Even with an SPIA, understand the total package you’re buying when you purchase an annuity:
· The income stream is all you get. The insurance company gets to keep the money you paid up front, as well as the long-term growth on that money.
· Once you pass away (or both you and your spouse pass away, assuming you selected a survivor option), the income stops, and your heirs get no benefit from the money you’ve invested in the annuity.
· Annuities are rarely indexed for inflation, and if they are, it’s a very expensive option to purchase. An income stream that looks sufficient today may fall woefully short later in your retirement.
· An annuity is only as good as the insurance company that issues it. If the insurance company becomes insolvent, your income stream could evaporate.
Even in today’s low-interest-rate environment, bonds can play an important role in a retiree’s financial picture. Because failing to pay on a bond can force a bankruptcy and potential change of control or liquidation at a company, you can be pretty sure that if a company can pay its bond, it will pay its bond. Still, bonds are risky assets, and the possibility of default exists. As a result, most retirees should stick with higher-quality bonds such as investment-grade corporate bonds or U.S. Treasuries.
The advantage of bonds is that they generally provide higher rates of interest than CDs or cash accounts do, while still having a known maturity date when you’re expected to get the bond’s face value back. That known payment schedule and expected maturity value makes them great investment options for money you don’t immediately need but expect to need in the next two to five years or so.
While bonds may keep up with inflation and taxes, they’re not likely to do much more than that given the current low interest rates. As a result, they’re better for medium-term capital preservation than for long-term wealth-building. A common strategy for retirees investing in bonds is known as a bond ladder. The retiree buys a series of bonds with staggered maturity dates, so they will frequently have bonds reaching maturity and generating cash. The proceeds from the maturing bonds can then be used to replenish CDs or cash to help cover near-term costs.
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5. Rental real estate
With rental real estate investments, retirees have the potential to get cash flows that are likely to increase along with inflation. Due to the tax treatment of real estate investments -- property owners must take a non-cash depreciation charge over time -- some of that income can even come through as tax-deferred.
There are risks and costs involved, however. You’ll need a fairly decent nest egg to get started as a landlord, as many lenders require at least a 25% down payment for investment real estate. In addition, you’ll need to pay the mortgage, taxes, insurance, maintenance, and repairs whether or not the real estate is rented.
Further, owning one or more rentals may be a job in and of itself, thanks to the need to find and replace tenants and respond to their service calls. Of course, you could always hire a management company to handle those duties for you, but as a small landlord, you’d likely give up a substantial portion of your revenue for doing so.
An alternative to directly owning real estate is to invest in publicly traded real estate investment trusts (REITs). Those are companies that specialize in owning and operating rental real estate. They’re required to pay out at least 90% of their income in the form of dividends, and many pay out even more than that.
Like any investment, real estate -- whether owned directly or through REITs -- involves financial risk, including the risk of loss of value. Still, over time, rents could potentially provide retirees an income stream that has a decent chance of growing in line with inflation over time as rents rise.
Stocks represent a great investment opportunity for money that retirees will need five or more years down the road. Long-term stock market returns have been around 9.6% annualized, even though near-term returns can be negative, returns are not guaranteed, and stock prices are always at risk of high volatility.
Stocks represent ownership stakes in companies. As those companies grow, their shares can increase in value, too. That means that unlike many other investments, stocks have the potential to beat inflation and taxes over time. With a big enough portion of your nest egg in stocks, in good years, you could harvest gains to replenish maturing bond and/or CD ladders. Because not all years are good years in the market, however, stocks are a lousy choice for money that you need to spend in the near term.