Why We Need New Ways to RetireLonger life spans, inflation, insufficient funding for social security, inadequate retirement savings, increased stock market volatility, health and living costs associated with keeping us alive longer (sometimes despite our true wishes), low dividend yields and insanely low-interest rates signal all demand new ways to retire vs the old way. Whew! That’s a lot of challenges ahead for us, right? Let’s see some ways to face these challenges victoriously.
The Best New Ways to RetireEveryone has a unique set of skills, interests, accumulated wealth and desired lifestyle that will lead them to the best ways to retire for them personally. With this in mind, let’s explore the many new ways to retire vs the old ways to retire. Be prepared for a shift in thinking and hopeful expectations (if not outright excitement) about your future.
Retiring EarlyThe first new way to retire early instead of waiting until you’re 65. You may have seen that the FIRE (Financial Independence Retire Early) movement has fueled thousands of early retirees as a move away from the old plan to retire at 65. How has this been achieved by most of the FIRE participants? Frugal living has been a big part of this movement for many. But many early retirees, like iconic Mr. Money Moustache, worked in a job, saved money, and invested in stocks. This was done from the career income of both Mr. and Mrs. Moustache. At the same time, they also got into real estate rentals, then online business from his blog, her Etsy store, now YouTube and more. Like us, Mr. Money Moustache works part-time managing his income streams, which now more than cover the cost of living. (But now he is divorced and is also considerably younger than us?) So, the first new way to retire is to do so decades earlier than the old way.
Income Streams Vs Spending SavingsThe old (but still prevalent) way to retire is based on saving and investing in stocks and bonds for decades, then hoping you’ll have enough retirement savings to live, along with social security. The problem is that this method may not work, but you won’t know for sure until it’s too late since future planning must be based on estimates and assumptions. The new way to retire is by creating income streams before retirement so that your investment and/or skill-based income exceeds your cost of living as we (and Mr. Moustache) did. This way, you can live off investments instead of spending them, at least in the first decade or two of retirement.
How Do Retirement Withdrawals Work?The old way to retire is based on withdrawing 2% to 4% of your savings every year to live so let’s look at that so we can compare it to the new ways to retire. The savings withdrawals are usually increased for inflation every year to maintain purchasing power. Since the effects of inflation compound and are on average about 2% a year based on more recent decades, anyone can see how serious this threat is for anyone not planning around it. Let’s look at the math, one of my favorite investing tools, for retirement withdrawal strategies. If you have $1,000,000 in retirement savings, the first year in retirement you will withdraw $40,000 to live if you choose to use a 4% withdrawal. The next year you would usually need to increase that amount for inflation to be able to buy the same things you bought the year before for the same amount of money. This withdrawal and spending pattern would continue for life or until you withdraw all your savings (which we “hope” won’t happen).
Income Streams from AssetsYou may already be thinking that the new way to retire with income streams to cover lifestyle expenses holds much appeal over spending retirement savings to pay the bills. There are many ways this income stream method can be accomplished but let’s look at some more math to explore this more. The reality is that both the old and the new ways to retire can overlap beautifully, as you’re about to see. After a few painful lessons, I learned it’s best to tiptoe into new ways of doing important things vs radically jumping in feet first.
Investment IncomeThe simplest way to establish higher income streams is by increasing the amount of income a traditional investment pays you. But there is a huge and unprecedented problem with this: With interest and dividend rates so low, this can be hard to do based on the way most people invest. Let’s look at the math for a nice round one million dollar retirement account.
Typical Stock IncomeUnfortunately, a typical stock income fund yields about 2% as of this writing. For example, a quick Google search shows that the popular low-cost Vanguard’s Equity Income Fund Investor Share (VEIPX) has an SEC yield of 2.68% as of this writing. Another popular stock dividend growth fund is the Fidelity Dividend Growth Fund, FDGFX. It yields 1.53% as of this writing. (I encourage you to click here to see the current yield from Google whenever you read this post.) And note that this particular fund is attempting to get both growth and dividends. From further research, I see a few funds yielding around 3% but they have higher fees of around 1%. So, let’s use a nice round 2% to estimate the income from a typical income (dividend) focused stock fund in a million dollar portfolio. (We’ll ignore fees and inflation for now. Unfortunately, including these would mean we actually have a negative real income return.)
The Math on a $1,000,000 Investment PortfolioIn the above example of an investment portfolio with $1,000,000, let’s assume a typical 60% is in stocks, or $600,000. Using the 2% explained above, the dividend income from $600,000 in a typical stock income fund is about $12,000 a year.
$600,000 x .02 = $12,000Assuming the balance of $400,000 is divided between a typical intermediate bond fund and a smaller portion in a money market account, it may be earning about 2.25% from interest these days.
$400,000 x .0225 = $9,000The total investment income from this typical investment portfolio, then, is about $21,000 a year. For purposes of computing investment income, we are ignoring capital gains since they are not income, and also not always a sure source. This is addressed more below for any of you committed to the idea of 10% annualized stock market returns.
The Problem with Low Investment Income in RetirementNote that there is a problem here. The annual retirement withdrawals of $40,000 (plus inflation) are not covered by the income generated in a typical investment portfolio. There is a $19,000 annual deficit in this example. This means an investor must depend on gains in the stock and bond market to make up the rest of the withdrawal or they will have to withdraw their capital or the past compounding of investment returns to live. And the amount of gains in the stock market is a factor of several things beyond our control, most notably the economy. And while sometimes the stock market can go up for an entire decade, sometimes it can have a nasty decade with losses as we saw in the 2000s decade. While we can look to the current and past to estimate future investment returns, counting on stock market gains to not run out of money in retirement felt too scary to me. It frequently works, but sometimes it doesn’t, and you don’t know until it’s too late. One common solution is to buy some sort of insurance product with minimum fixed income, but this solution is limiting since it has lower than the market return. This realization is exactly why we decided to create income streams after doing the math 15 years ago well before FIRE was vogue. Let’s look at some solutions other than (or in addition to) an insurance product like an annuity.
Proactive Income InvestingRather than settle for the low yields we saw above, a more proactive investor may simply choose to manage his own portfolio, invest in an alternative fund or with a wealth manager that gets a higher overall portfolio income yield of a very reasonable 6%. Let’s do the math on that. In this case, the investment income from $1,000,000 would be $60,000 a year.
$1,000,000 x .06 = $60,000Wow! The $60,000 of income would cover the withdrawal amount as well as give the investor some extra income over the retirement withdrawal of 4% (plus inflation) used above. This means by simply being a more proactive income-focused investor a retiree can stretch the amount of retirement savings over many more years, or even decades. This is a fairly simple way to retire for investors with a good amount of savings willing to make a little more effort beyond settling for the most popular stock dividend mutual funds or ETF’s. Many financial advisors and wealth managers are focused on higher income generating investments for their clients. While there will be a fee, you won’t have to do the research and work. They have already done it for their other clients and have a ton of quality research to back their income investment choices.
Alternative Income StreamsNot everyone has $1,000,000 in their retirement portfolio, while others have more. The good thing is that in addition to increasing income from investments in stocks and bonds, investors can increase income in my other ways. What I have learned over the decades is that most wealthy people don’t sit back and lock in income from lower-yielding investments like the first example above. They create income from more alternative and different sources that have higher upside. Here are a few examples, and things we have done, too.
- Stock Option Income
- Real Estate Rental Income
- MLP Income
- REIT Income
- Many Various Types of Online Business Income
- Consulting Income
Income Stream Cheat Sheet InspirationI remember how confused I was when we first began creating income streams after we stumbled into early retirement. And we made a ton of mistakes because it was all new to us. While writing about this recently, I was drawn to create an Income Stream Checklist to help others quickly see which income stream makes the most sense for them based on their own situation and desired lifestyle. I’m happy to share it with you with one promise in return: you’ll use it right now to help you find the best new way to retire that is based on income instead of withdrawing retirement savings to live. Click here for my income stream cheat sheet with 15 income stream ideas, the time it takes to manage each type, savings needed to establish each income stream, the risk level for each strategy, and the potential income from each
New Ways to Retire SummaryAs you can see, the new ways to retire have more potential than relying only on the old ways. Ideally, retirees have enough savings to combine the new ways to retire with the old ways for a wonderful blend of traditional passive and more proactive alternative income sources. Change is happening. And in this case, it’s for the good. Despite rising costs, with the expansion of the internet, better information, and more investor choices, there are more opportunities for new ways to retire with plenty of income than previously existed. Let’s embrace it to retire comfortably when we want.
The information on this website is for education only and is not to be construed as personal financial advice.