According to a 2012 Employee Benefit Research Institute poll, only one in seven Americans are confident that they will retire with enough money to live comfortably, even though one in three expect to work past the age of 65.The reason: Saving for retirement is increasingly difficult for families faced with the costs of rising healthcare, purchasing a home and sending children to college.
In fact, a middle-income household is likely to spend almost $227,000 to raise just one child to 18 years of age, according to a 2011 article in CNNMoney, and that doesn’t include college expenses. The College Board reports that attending a four-year program averages between $22,000 and just over $43,000 per year. Include more than $20,000 per year in healthcare costs for a family of four (including the employer’s portion), and it’s easy to understand why the average American is frighteningly underprepared for retirement.
One obvious solution to this dilemma is to increase the investment return on what you do have saved. The results can be dramatic. For example, if you’re 45 years old and have $62,000 in an account earning 3%, it will grow to almost $112,000 by age 65 with no additional investment. However, if instead it earns 9%, that $62,000 will become a more impressive $347,500 over the same period of time. Striving to increase your investment return is a no-brainer if you want to have a more comfortable retirement, but pulling it off isn’t quite so clear-cut.
Relationship Between Risk and Reward
There has always been a direct relationship between risk and reward; the higher the return, the greater the possibility of loss. Before implementing any strategy to improve your return, you need to understand your risk tolerance and your capacity to withstand the consequences of the worst-case scenario. Some high-risk/high reward investment strategies require you to stay the course during difficult times. In these cases, if you’re unable to stomach a certain amount of loss, or even the threat of loss, you may undermine the entire strategy.
Consultants, pundits and philosophers have glorified risk-taking for centuries from the ancient Virgil (“Fortune sides with him who dares”) to Clint Eastwood (“If you want a guarantee, buy a toaster”). But investors would be better advised to follow the counsel of the Sage of Omaha, Warren Buffett, who advised, “Risk comes from not knowing what you’re doing.” In other words, if you elect to pursue a more aggressive investment strategy, learn as much as possible about the strategy, the investment and possible outcomes before you take action. If there are ways to achieve the desired gains without assuming any or all of the potential risks, be smart and use them.
Strategies to Consider
The following investment moves can increase your potential returns dramatically, but will increase your risks of capital loss. These suggestions are based upon a 20-year investment horizon and will be subject to considerable volatility during the interim. You should also note that timing is everything. In other words, regardless of what happens during the interim, when you buy and when you sell will be the primary determinants of your actual investment return.
1. Invest in Equities, not Bonds:
Inflation is pretty much a fact of life; a dollar repaid tomorrow will have less purchasing power than the same dollar borrowed yesterday. Companies respond to higher costs by raising prices and protecting profits, while reinforcing the economy’s inflationary trend. Conversely, debt instruments fall in value reflecting higher inflation and higher interest rates. According to a study by Crestmont Research, the average annualized return of the S&P 500 for every 20 year period since 1920 has been 4.2% above the rate of inflation , which is at least 50% higher than an investment in long-term debt. To improve your investment return, invest your capital in the equity markets.
2. Focus on a Few Dominant Companies:
While diversification reduces risk, it also dilutes investment return. For example, a $50,000 investment in Apple in 2002 was worth $3.9 million at the end of 2012. However, the same investment in the S&P 500 (across a range of companies) would be worth only $77,000. Companies like Apple, Walmart and Southwest Airlines dominate their industries by changing the rules of the game and maintaining their edge with superior management. While it is almost certain that these companies will eventually decline, no one knows when. Companies like Google and Amazon may continue to dominate their industry another five, 10, 15 years or longer, and investors who are along for the ride will be richly rewarded.
3. Buy Residential Rental Properties:
Middle-income wages have stagnated for the past decade, while high unemployment is likely to continue due to the impact of technology and the worldwide availability of labour. As a consequence, home ownership has fallen over the last decade with fewer people able to afford mortgages or down-payments. This, in turn, has led to increasing rental rates. In fact, more than 4.2 million new renters are expected to enter the market through 2016. Companies that specialize in residential real estate (and investors who support them) are poised to benefit from this long-term fundamental change in American society.
4. Concentrate in Precious Metals:
Even though Mr. Buffet doesn’t invest in gold due to its unproductive nature, a significant number of highly vocal investors and investment firms consider this metal the best long-term investment. In the last 10 years, gold has soared from about $280 per ounce to over $1,600 per ounce. During periods of economic uncertainty, investors from around the world flock to buy gold, and supply of the commodity has remained relatively fixed for a decade or more. As long as demand continues and supplies stay fixed, gold will likely continue its rise. Some analysts even predict that silver, with its multiple industrial uses, will be a better long-term investment than gold.
5. Invest in Your Self:
In a volatile job market, career opportunities and earnings are constantly evolving. For those who are stuck in a profession likely to be outsourced or obsolete, who are lacking a college education or seeking a job in a demanding industry, the best investment may be additional education.
According to a report by the Georgetown University centre on Education and the Workforce, a bachelor’s degree holder earns, on average, almost $1 million more than a high school graduate, over a lifetime. In some industries, having a master’s degree leads to higher salaries and increased promotion opportunities. If more education or technical training will expand your opportunities and improve your earnings, make the investment.
Predicting the future economy, the impact of the economy upon specific industries and companies, or the financial return of any investment is difficult, if not impossible. There is no single formula or recipe to follow to guarantee that you will reach your financial goals. The only certainty in life is change, therefore, the critical components of investment success are knowledge, awareness, flexibility and good sense.
The Bottom Line
Paul Samuelson, American economist and Nobel Prize winner in Economic Science, didn’t agree that risk-taking and investment returns were necessarily related. “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Vegas,” he said. Before incurring additional risks in your retirement portfolio, be sure to understand the alternatives and the consequences of your strategy. What you don’t know may not kill you, but it can certainly cost you money.
Michael Lewis is a retired corporate executive and contributor for MoneyCrashers.com, where he writes about current topics related to economic policy such as the privatization of Social Security, the importance of Medicare, and more.
This story was originally published by Investopedia.
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