I consider myself to be an expert of sorts on retirement. Not because I’ve studied the subject, but because I’ve retired three times.
Yes, I’m a three-time failure at retiring. But I’ve learned from my mistakes. Today, I’d like to tell you about the worst mistake retirees make.
It’s a common mistake… Yet I’ve never heard it mentioned by retirement experts. Nor have I read a word about it in retirement books…
The biggest mistake retired people make is giving up all their active income.
When I say active income, I mean the money you make through your labor or through a business you own. Passive income refers to the income you get from Social Security, a pension, or from a retirement account. You can increase your active income by working more. But the only way you can increase your passive income is by getting higher rates of return on your investments.
When you give up your active income, two bad things happen:
First, your connection to your active income is cut off. With every month that passes, it becomes more difficult to get it back.
Second, your ability to make smart investment decisions drops because of your dependence on passive income.
Retirement is a wonderful idea: Put a portion of your income into an investment account for 40 years and then withdraw from it for the rest of your life. Once you retire, you won’t have to work anymore. Instead, you will fill your days with fun activities: traveling, golfing, going to the movies, and visiting the kids and grandkids.
But consider this: A retirement lifestyle for two, like the one I described above, would cost about $100,000 per year.
How big of a retirement account do you need to fund that?
Let’s assume that you and your spouse could count on $25,000 a year from Social Security and another $25,000 from a pension plan (two big “ifs”).
To earn the $50,000 balance in the safest way possible (from a savings account), you’d need about $5 million, because savings accounts only pay 1% at most right now.
But middle-class American couples my age are trying to retire with an account in the $250,000 to $300,000 range. And that’s where the trouble begins. To achieve an annual return of $50,000 on $300,000, you’d need to make 17% per year.
Getting 17% consistently over, say, 20 years may not be impossible, but it’s very risky—too risky for my tastes.
I retired for the first time when I was 39. I put my money into AAA-rated municipal bonds (very safe at that time), yielding between 5% and 6%. It didn’t take long to figure out the math: At those ROIs, I could not maintain the lifestyle I wanted. To get higher returns, I would have to put my money into riskier assets. I had an instinct—correct, I think, in retrospect—that would end badly.
So what did I do? I went back to work.
I went back to earning an active income because I didn’t want to spend my days trying to “beat” the market and my evenings worrying about how I was doing. And do you know what happened?
The moment I started earning money again, I started to feel better. Retirement isn’t supposed to be a time of worrying about money. But when your income is entirely dependent on the return you’re getting on your investments, that is exactly what will happen.
I am not saying that you should give up on the idea of retirement. On the contrary, I’m saying that retirement might be more possible than you think.
But you must replace the old, defective idea that retirement means living off passive income only. Paint a new mental picture of what retirement can be: a life free from financial worry that includes lots of travel, fun, and leisure. Funded in part by active income from doing some sort of meaningful work.
The first benefit of including an active income in your retirement planning is that you will be able to generate more money when you need to.
But the other benefit—which is less obvious—is that it will allow you to make wiser investment decisions because you won’t be a slave to your investments.
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