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How to Really Prepare for Retirement

Seth Jentner05/01/2012

Everyone wants to know what the market will do and where people should invest their money. Market prognosticators line up to give opinions of what they think will happen. Yet there are so many different opinions.

It’s a topic on many people's minds. But here are the facts: As bright as some market prognosticators are, none are able to predict the market correctly year after year. Some will get it right, and some will get it wrong. But no one knows who will be right until we have the benefit of 20/20 hindsight!

So what are you to do to invest for retirement? Should you just put money into government bonds or guaranteed investments like FDIC insured CDs or fixed annuities?

Yes, you should consider these investments. But for most people, these types of investments should only be part of your portfolio. Most investors, including retirees, should invest into a well-diversified portfolio, which would include cash equivalents, bonds, and stocks.

The third cornerstone of prudent investing states that concentrated investment portfolios can be dangerous and are not worth the risk. People can readily understand how this applies to the risk of owning too much stock in one company, but many people overlook this fact when they decide to place all or most of their investments into fixed income investments or CDs. If tax rates increase and if inflation increases, these fixed investments can leave investors behind. Here is a simple example:

If a retiree invests today into a fixed income investment yielding 3%, and tomorrow his income tax rate increases to 33% and inflation increases to 4%, his net (after tax) yield is only 2%, while his cost of living increased by 4%. This is what is called “safely going broke.” Even if he preserves his money, his purchasing power decreased, and he may be forced to reduce his standard of living if this trend continues.

So what should a person near or in retirement do?

Because the future is uncertain, the wise course of action is to:

  1. Live within your means. That means use debt cautiously.
  2. If you are still working, pay yourself first with regular deposits into your investment account, like your 401(k), 403(b) or IRA retirement plan. Invest in a well-diversified portfolio of cash equivalents, bonds and stocks.
  3. If you are already retired, your investment portfolio should still be well diversified, although it should probably be tilted a little more toward cash equivalents and bonds as compared to a pre-retiree. Monitor the withdrawals you take out of your portfolio to make sure they are at a safe withdrawal rate.

Implementing these principles will put you on the right path toward retirement independence.

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