Let’s say you’re looking to retire and want to bring in the average American salary in your golden years.
It’s a good goal—and more than enough cash for many retirees, especially if you live outside places like, say, San Francisco, where the average one-bedroom apartment rents for $3,300 a month (!)
So how much are we talking about here?
As of March 2017, the average US worker took home $896.60, according to the Bureau of Labor Statistics. Assuming 50 working weeks a year, that’s $44,830.
Okay, so we need to get $44,830 in pre-tax passive income. Where are we going to get it?
Most people look to three options: bonds, stocks and real estate.
And sadly, that’s where many lose their shot at our $45k income stream.
Treasuries, Stocks Need Over $1M Just to Be “Average”
You’ll notice I’ve added one more column to the chart above, called “CEF Portfolio.” It clobbers US Treasuries, index funds (through which many investors buy stocks) and real estate, plus it gets us more than 99% of the way to our goal.
I’ll have more to say about CEFs in a moment—including the names of 9 of these funds boasting yields from 9.9% all the way up to 11.3%!
First, let me explain why the other three choices come up short.
Treasuries: A “Safe” Way to Get Meager Income
US Treasuries will require the biggest nest egg, simply because they have no chance of appreciating in value. With Treasuries, you’re effectively lending to the government and getting cash flow in exchange. The good news is this income is tax-free, so we need to earn less than we need to elsewhere because we won’t have a tax bill to deal with.
The bad news is that if we lock up our cash for 30 years (!) with no risk-free way of withdrawing that cash without potentially losing some of our principal, we need over $1.2 million invested to get $35,864 in post-tax income (which is pretty much what $44,830 would turn into for most Americans after tax). That’s because we’re only getting a 2.96% yield at today’s Treasury rates.
A millionaire can only get an average salary? We need to do better.
Index Funds: Retirement Roulette
Meager bond yields are why many people turn to index funds, which charge low fees and track the broader stock market. There are a couple problems here, the biggest being that market crashes can and do happen.
I examined the danger index funds can pose to retirees on April 4. But for now, let’s imagine you were going to retire at the start of 2008, and let’s assume you have our $1.2 million to invest in the Vanguard 500 Index Fund (NYSEARCA:VOO).
Here’s what would have happened in the following years:
Index Funds Take the Brunt of a Downturn
That’s right—you would have been in the red for five whole years! Normally this isn’t that big of a deal … if you’re looking to keep your investment for a decade or more and not touch it. In fact, if you’re planning to invest more while you keep working, these dips are opportunities to buy.
But that means nothing if you’re planning to retire and actually use your investments. For retirees, these market declines were absolutely devastating.
A Crushed Nest Egg
Because the retiree depends on market gains to keep the portfolio from going down AND to provide income in retirement, a downturn is doubly devastating.
To get around this, finance academics have studied historical market returns in the so-called Trinity study. According to that data, to get that $44,830 pre-tax income, we need to invest $1.2 million to guarantee that we won’t run out of money in retirement.
That’s almost identical to what we would need if we choose safer US Treasuries, so what’s the point of an index fund?
If you’re nearing retirement, not much. So let’s move on.