If you are reading this portion of our website, then there is most likely a gap between how much you need to save, and how much you can save to generate the “lump sum” amount you will need at the age you want to stop working.  There are ways to close the gap.

• Increase your allocation towards financial independence by reducing your

              spending or increasing your income.

• Increase your return on your investments to have it grow faster.
• Work longer in life to reduce the number of years you will be living off of

              the “Lump Sum” amount.

• Work during retirement

Increasing you allocation

There is really only two ways:  Decreasing your spending or increasing your income so that you have extra money to allocate towards your retirement goal.  Start by creating a budget.  Scrutinize your spending.  Attempt to cut any activity that is taking money away from you reaching your financial independence. The second way is to increase your income.  We have an entire section coming soon on how to create a small business with little to no money.   Establishing a small business will help increase income while also offering potential tax deductions to allow you to retain some of the money you currently pay in income taxes.

Increase your return on investments

The amount of return you make on your retirement investments affect the amount you will have when you retire.  If you have a 401K and your asset allocation (a fancy way of saying where your money is invested) is very conservative, then you are restricting the growth rate of your investment.  Everyone needs to balance the volatility of their investments and their expected return; basically, how much risk they wish to bear.  However, two things are for sure: The closer you are to retirement, the less risk you would want to bear; and if you bear no risk, you will not have any return.  The key is finding ground between the two that works for you.  If you are reading this section of The Financial Swami, then you most likely have a gap between your financial independence and your current retirement investment strategy.  You may want to increase your potential for return by bearing more risk.  While people do invest in:

• Stocks

• Bonds

• Treasuries

• Saving accounts / Cash

Only stock and bond typically have a rate of return greater than inflation.  The approximate annual rate of return for them over the past 80 years has been:

• Stocks 11%

• Bonds 5%

With return, comes risk.  While you hear the word risk, what you should really think of is volatility.  Volatility is a measurement of how much the investment moves in relationship to its average.  While stocks have a high average rate of return, they also are highly volatil (even more than 11% return average).  What this means is you will have to be willing to ride out the down cycles of the volatility to have a chance to achieve the higher return. 

Diversity is a strategy to minimize the risk, but it does not eliminate it.  Many people talk about having diversity in their investment portfolio by having a mixture of Stocks, Bonds, Treasuries and Cash.  One can also diversify with just stocks.  This can be done by investing in stocks from different sectors, different countries, different industries, ECT.  While this type diversity doesn’t provide as much diversity as owning the other investment vehicles, it does add a level of diversity why increasing the potential for return.  The key is to know how correlated each stock is to a benchmark.  Say your benchmark is the Dow Jones Industrial Average or the S&P500.  Then you would want to know historically, how the stock has moved in relationship to those benchmarks.  You want to know if the stock price rises and falls in relationship to the S&P500 rising and falling.  A perfect correlation is 100% or 1.  If the stock moves in the opposite direction of your benchmark, than the correlation is -100% or -1.  You want to have your portfolio balanced, meaning some stocks moving with your benchmark and some moving against your benchmark.  Below is a sample key:

            .70   to  1.000 high correlation to the chosen benchmark

            .11   to   .690 moderate correlation

            .10   to  -.100 no correlation

            -.11  to  -.690 moderate negative correlation

           -.70   to  -1.00 high negative correlation

You will also want to diversify by choosing stocks of different company sizes and value: Growth or Value, and Large, mid or small market capitalization.

If this sounds like a lot of work, it is.  Then again, this is the fundamentals of a mutual fund.  A mutual fund is a collection of different investments.  There are thousands of different mutual funds ranging from all stock funds to all bond funds to blended funds.  You can buy different mutual funds that have different stock make-up which react in correlation or completely against a benchmark like the S&P500.

So if you want to increase your return and hopefully reach your retirement goal, then consider buying mutual funds that are stock funds.   You can reduce your risk by changing your investment selections to bond funds as you approach your retirement age.  Check out the 10 year cushion strategy for an investment strategy that increases your stock exposure while balancing your risk over the next ten years.

Work Longer

Working longer is an option to help reduce your retirement funding gap.  The option works to reduce the gap two ways:  First, it generates additional income to help fund your retirement and second, it reduces the number of years you will be living off of your savings.  Use one of our retirement calculators and plug in different retirement ages to see how retirement age affects the amount you need to save.  Many times a few extra years of working can drastically change the situation.

Work during retirement

You always have the option of working during retirement.  This sometimes happens anyway to prevent boredom.  You can reduce your wage replacement ration in the retirement calculators by having some of the money you will be living off come from a part time job.

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