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5 Rules of Thumb For Retirement Investments

5 Rules of Thumb For Retirement InvestmentsEvery once in a while, it helps to get back to basics with retirement investments.

After all, Self-Directed IRA investing is like any sport: If you master the fundamentals of the game, you will find yourself much better able to adapt to any situation.

Pay yourself first. This means that at least 10 percent of your income, right off the top, should go to advancing your own long-term financial security. Not to short-term needs, and not to enriching someone else’s. Of course, carelessness with debt, or buying too much house, or any number of other common mistakes can make paying yourself first extremely difficult, as debt service overwhelms your income and gradually restricts your options. Paying yourself first, however, can go a long way to preventing this from happening.

Increase that 10 percent. That 10 percent is a bare minimum. That’s for people at the very beginning of their careers, still eating Top Ramen for dinner. As you get older and more established, your disposable income should go up. So should your minimum acceptable savings rate.

Cash Counts. Yes, cash counts in the bank, but inflation can tear the guts out of bank savings accounts over time. Cash counts in equity investing, too: Recent research by Lowell Miller of Miller/Howard investments, has found that stocks that pay regular dividends consistently outperform stocks that don’t pay dividends – and that the higher the dividend, the greater the risk-adjusted outperformance.

Miller’s analysis was of publicly-traded stocks in the S&P 500 – but the same logic applies to just about any investment – the ability to come up with a cash dividend on a regular basis is a useful acid test for retirement investments. Even if you choose to reinvest those funds, it’s good to have enough internal cash flow within a given investment so that you have a choice.

That’s not to say there aren’t excellent early-stage retirement investments in the venture capital and private equity world and the closely-held business world that don’t pay a regular dividend or even generate a lot of cash internally. Many of these will have a sale or acquisition strategy rather than a strategy of eventually paying dividends to the current owners. That is, they are hoping their technology or service will be purchased outright by a bigger fish. But understand where these companies lie on the risk axis!

Multiply by 25. This rule of thumb refers to the amount of money you should have in a retirement nest egg by the time you hang up your spurs. Estimate your desired retirement income. Then multiply it by 25. This is the approximate level of savings planners recommend their investors have to generate income when they retire.

This is a very broad rule – someone with a lot of in Roth real estate IRAs may be able to get away with quite a bit less, with a healthy portfolio of real estate generating tax-free rental income. You may be able to generate better cash on cash returns by concentrating on non-publicly traded, unconventional assets through the use of self-directed IRAs. Indeed, that’s the point, isn’t it?

Diversify. Now, diversification doesn’t mean you necessarily have to own thousands of different positions – though that’s one way to do it. But the downside to that approach is that the lousy investments dilute the effect of the good ones. Another way to approach diversification is to try to own a few excellent positions in several different asset classes and industries. The idea is that you will still get the strong cash flow properties of the best appropriate investments in each asset class you can find, even though any one of these holdings may be a bumpy ride. Their volatility should largely be mitigated by other bumpy rides in other asset classes, which aren’t closely correlated with one another.

This is the approach favored by Warren Buffett, who, while he usually favors equity holdings, counsels “put your eggs in just a few great baskets – and then watch those baskets!”

 

 

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