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September 25, 2007

How to Save for Retirement

by Dan

I’ve been thinking about retirement and making some changes to our investments, and it occurred to me that most of the financial advisers out there have got it wrong when it comes to retirement. For example, David Bach, author of The Automatic Millionaire, talks quite a bit about saving for retirement using a 401(k) as if that were the point. Sadly, this is confusing the means with the end.

The phrase “save for retirement” generally mean spending less than you earn and putting the left over cash into some form of account targeted at retirement, such as a 401(k), IRA, or Roth IRA. But saving money isn’t really the point. The real goal is to live comfortably during retirement when you can no longer work to earn an income. Or in other words, to collect enough passive income to live on.

One (overly hard) way to do this is to save a bunch of money in a bank account, and then just live off of the principle. This isn’t the best because it requires a lot of cash. Investing the principle and living off the interest costs less because you’re earning interest on the unused principle. And if you’re going to invest, you might as well invest now when the consequences of a market dip or making a mistake aren’t quite as serious. This is how we got government sponsored retirement accounts.

But the right goal is not to save money or contribute to a retirement account, which are means to an income during retirement. The right goal is to create a stream of passive income on which you can live. A Roth IRA does meet that goal, but there are easier ways that require less cash. That is one reason for my interest in investing in real estate and starting a business, but anything that puts money in your pocket each month will work. The best thing is that, by buying or creating the right assets now, I can “retire” the moment my passive income is enough to meet my needs.

So I’m trying to find and buy assets that put money in my pocket each month without requiring work on my part. I’ve had to learn a lot, and I’ve made mistakes, but I’m optimistic about making things work during retirement. I only mention this because it just occurred to me today how the mantra “save for retirement” has set so many people on the wrong track.

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