When you finally reach that age where you are ready to move beyond your primary career and retire, one of the most important decisions you will face in your life is how you manage and invest your retirement funds. For most retirees, the goal of any good retirement fund is to generate what is known as passive income. In short, passive income is money such as dividends, interest, rents, and capital gains that you can use to pay your bills, take vacations, cover medical expenses, and otherwise use to enjoy your life, without having to work. Passive income is the opposite of earned income, which requires your labor.
The Primary Goal of Your Retirement Fund Money Is To Protect Your Net Worth
Before we start talking about investing your retirement funds, we need to clarify one thing. Your primary goal when it comes to putting your retirement funds to work is to protect your net worth. That means not losing money. Any gains are nice, but you are now in the distribution phase of your life, to use a financial industry term. That means you are not longer in the accumulation phase so additional gains should be considered nice icing on the cake but a secondary consideration to making sure you don't wake up destitute and unable to heat your home (or worse, lose your home altogether).
With that said, let's look at your options. When it comes to retirement, the most popular options often involve splitting money between a handful of asset classes. This policy is known as asset allocation. Popular asset classes for retirement funds include:
- Cash and Cash Equivalents - The biggest risk here is that the money won't keep pace with the inflation rate and you'll lose purchasing power. This is the money you need to be able to access quickly in the event of an emergency.
- Bonds and Fixed Income Investments - These can include U.S. Treasury bonds, corporate bonds, tax-free municipal bonds, and other debt instruments that pay you interest income in exchange for loaning money to the issuer. The biggest risk is inflation and the chance you select too high a bond duration. For more information, read the New Investor's Guide to Investing in Bonds.
- Real Estate - If conservatively financed or, better yet, owned outright, real estate investment can be protected against inflation because the owner has the potential to raise rental rates over time. Investing in real estate can be a field of study unto its own. I know investors who specialize in rental houses, others who prefer apartment buildings, some who like to build office complexes, and still others who prefer storage units and car washes.
- Business Ownership - Sometimes this comes in the form of investing in stocks, especially high-quality blue chip stocks that pay cash dividends. Other times, it might come in the form of an operating business such as a popular franchise, although this isn't technically passive income. For example, a corporate executive might retire and decide to start a second career with his spouse running a Dunkin' Donuts franchise in his hometown as a way to stay busy, interact with the community, put his knowledge to work, and earn money.
Notice that the list doesn't include investing in mutual funds because a mutual fund is merely a conduit that owns an underlying asset such as one of these types of investments.
One popular retirement fund investment plan is to use the Talmud asset allocation model, which calls for 1/3 cash and cash equivalent reserves (which might also include short-term bonds), 1/3 real estate, and 1/3 business ownership. Another option is the so-called passive income asset allocation model, which might include the use of special types of annuities from highly rated insurers to provide a stream of guaranteed income for life.
Which is right for you? It depends upon your personality, your risk profile, how comfortable you are with market fluctuations, and even your tax situation. Another big consideration for investing you retirement funds is your own area of expertise. If you spent your life as a construction manager, you are going to have insights into the quality of rental properties that other people might not have. This could provide a valuable source to tap during your investment research, helping you avoid big mistakes.
