Everyone wants to have a comfortable retirement without worrying about having enough money to cover their regular expenses, and enough left over to fund hobbies and a few vacations. But some of those same money anxieties can stop you from investing for retirement.
Here's the thing, though. Investing is crucial to retiring rich. Stockpiling cash alone probably isn't enough to get you to retirement with enough savings, and even then, eschewing investing in retirement could lead you to run out of money.
An example of a bad retirement savings plan. Image source: Getty Images.
Why you need to invest for retirement
Which of these scenarios sounds more feasible?
- Save $25,000 per year for 40 years
- Save and invest $3,000 per year for 40 years
Obviously saving $3,000 is easier than saving $25,000. But by investing that $3,000 in the stock market -- even in something as simple as an index fund -- you'll be able to end your 40-year career with about the same amount of money as you would if you'd stuck $25,000 of cash into a savings account every year.
Over the last 50 years, the S&P 500 has produced a nominal return of 9.4%. At that rate, $3,000 per year will turn into more than $1.1 million in 40 years.
In fact, if you want to retire rich, you'll probably need a lot more than $1.1 million 40 years from now. Even with modest inflation of 2.5%, that amount will be worth just a bit more than $400,000 in today's dollars. So, saving $25,000 in cash may not even be enough to get you to retirement in 40 years.
Staying there
You might have heard of the 4% rule. It's a simple way to figure out how much you can spend in retirement. If you hold a portfolio evenly split between stocks and bonds, you'll be able to withdraw 4% of the starting amount every year without running out of money during a typical 30-year retirement.
Now, you may be thinking, won't I be able to withdraw 4% for 25 years if I just leave everything in cash? Of course you could, but that strategy has a few big problems. First of all, there's no inflation adjustment. The 4% rule includes inflation adjustments, so if we have a year of high inflation, you'll be able to maintain your quality of life by withdrawing a bit more from your portfolio.
Second, the all-cash strategy guarantees you'll run out of money at 25 years. What if you're still alive and kicking 25 years post-retirement? You'll be relying entirely on social security. That's not what anyone would call a "rich retirement."
In the vast majority of cases, the 4% rule results in a portfolio nominally larger than the starting portfolio after 30 years. That protects you against living a very long life, may give you some buffer for unexpected expenses later in life, and ensures you have something to leave to your heirs.
Investing your cash is the only way you can realistically obtain enough savings to retire with enough money to fund your living expenses, vacations, and hobbies. And if you don't stay invested through retirement, you'll probably run out of money and find yourself pinching pennies later in retirement.
