I've read an article on CNBC titled "With Retirement Savings, It’s a Sprint to the Finish". Your average financial advice would tell you to save a good amount of your salary into a well-diversified portfolio and you should retire with relative ease. Your financial advisor is not telling you that if you have a bad set of returns you may not retire with relative ease. Basically, the advisor is saying you just have to cross your fingers. They might as well to tell you to go to Las Vegas. I have a problem with this advice.
Although I am a believer that people should save a good amount of their salary for retirement, they should become aware of the mathematics. Your financial advisor will never tell you that if you are dealt with a bad set of returns on your retirement portfolio the power of compounded interest will work against you, especially if you are close to retirement or just recently retired.
Compounding works on two simple concepts, time and performance. The longer that time period the higher your earliest investment will drive your total assets in the portfolio. In addition, the longer time period will give you enough time to hopefully recover any losses. That is why one start really young and invest as much as they can afford. BUT YOU ALREADY KNOW THIS!
How can we increase the odds of achieving our retirement goals? There are many investment strategies to help accomplish your goals. They depend on your investment risk appetite. If you are only comfortable with safe investments then one must invest a large amount of money consistently since the investment return will be quite small. The compounding power on a safe investment will be minimal.
Another approach would be to take on more risk and therefore possibly obtain a much higher rate of return on your investment. The problem with this approach is you can actually experience losses on your investment and will need a much higher return thereafter to make up the difference. Neither approach seems appetizing.
Now I am not a retirement nor investment expert but the approach I have taken is to investment in companies that have issue large dividend consistently over time in a tax sheltered account (IRA or ROTH). In addition, this dividend must be growing at a double digit rate.
The reasons I choose this approach is because these companies have strong cash flows, especially free cash flow, have intelligent and conservative management, and their business models have been proven over time. These dividends provides a cushion against loses that will grow in strength over time because management is increase the dividend rate at a reasonable percentage consistently. In addition, since I am earning this cash in a tax shelters account, these dividends will contribute to the power of compounding with no outflow to the government.
This strategy provides me with the benefit of no tax outflows, the investments are earning dividends which is free cash at no cost to you, and the investments are made in individual high quality stocks which offer a fair amount risk but with no management fee. Therefore they all contribute to power of compounding. I don't know about you I rather increase my odds of achieving my retirement goals by investment in companies that have relative high dividend payouts than just leaving it to random chance.
Source: http://www.cnbc.com/id/41220052
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