How the "Big White Lie" of Investing Almost Cost Me My Retirement (Secret 7)

Learn from my mistake and discover the most important factor in building wealth quickly

I consider myself an expert of sorts on retirement. Not because I've studied the subject, but because I've retired three times. Yes, I'm a three-time failure at retiring. But I've learned from my mistakes. Today, I'd like to tell you about the worst mistake retirees make. It's a very common mistake. Yet I've never heard it mentioned by retirement experts. Nor have I read a word about it in retirement books. The biggest mistake retired people make is giving up all their active income. You can get two different types of income. Active income is the money you make through your labour or through a business you own. Passive income refers to the income you get from a pension, or a retirement account. You can increase your active income by working more. But the only way you can increase your passive income is by getting higher rates of return on your investment (ROI). [A return on investment, or ROI, is a profitability measure that evaluates the performance of a business by dividing net profit by net worth.] When you give up your active income, two bad things happen: First, your connection to the source of your active income is cut. I'm talking not just about the business you had or worked for, but also the people you knew. (These are valuable connections you might want to go back to someday. But with every month that passes, it becomes more difficult to get back.) Second - and this is something you may not have considered - your ability to make smart investment decisions is debilitated because of your dependence on passive income. (I'll explain this later.) Retirement is a wonderful idea: Save a portion of your income every month, let it grow in a tax-deferred investment vehicle, and accumulate a vault of wealth. Then, 40 years later, tap into that vault to fund 20 years of easy "retirement" living. No work. No stress. Nobody to kowtow to. Just traveling, golfing, going to the movies, and visiting the kids and grandkids. Yes, it's a great idea. But it was never realistic. Prior to the 20th century, retirement was a rarity. Most people worked until they could no longer work and then "retired" into the houses of their children. The only generation that experienced "the dream" was my parent's generation - the men and women who bought starter homes and entered the workforce after World War II. They had good timing - as the USA was entering a 30-year growth spurt in business and real estate. They made and saved money, but the bulk of their retirement funds came from selling their homes - homes they had bought for $10,000 or $15,000 in 1950 for 10 times that amount in 1980. For every generation since then, the promise of that kind of retirement has been nothing but a big white lie. Consider this: An average retirement lifestyle in India, would cost at least, (depending where you live), Rs 600,000 per year. But that's after tax. [Taxes can be complicated, with several tax rate percentages (marginal rate and effective payable rate) that combine to equal what you actually pay. Now, tax structures are different in different places.. To keep things simple for this essay, we're going to use this Indian example where the number would be similar at 30%] If you were in the 30% tax bracket, you'd have to earn about Rs 900,000 (rounding up). So let's use this Rs 9 lac round figure. How big of a retirement account do you need to produce Rs 9 lac of cash flow each year? Normally you should be able to count on some pension plan, to give you a small income each year. But we all know that the amounts generated from these plans right now are so small we can leave it out of our calculations. To earn the Rs 900,000 in the safest way possible (from a fixed deposit), you'd need about Rs 9,000,000, because savings accounts pay - at most - only 10% right now. But let's say you were confident you could earn 20% from the stock market (an ambitious number). You'd still need a nest egg of Rs 45 lac to gross Rs 9 lac per year. But let's add another dimension to make this more realistic. Owing to a very high inflation rate and rapidly declining purchasing power of the rupee, in our own calculations we have to add another dimension, adjusting for inflation. Even if you achieve a return of 20% on your investment, adjusting for the current inflation rate, let's say 8%, you should only count on 12% of that return, so as not to deplete your corpus too quickly. And at this time, we are only talking about one individual. If you calculate the number as a couple, it almost doubles. The problem: Most middle-class couples my age are trying to retire with much less in their account. And that's where the trouble begins. To achieve a consistent return of 20% over, say, 20 years may not be impossible, but it's very difficult and very risky - too risky for my tastes. A Lesson Learned From Retirement No. 1 I retired for the first time when I was 39. I had a net worth of about $10 million, half of which was liquid. I thought I had all the money I would ever need. As it turned out, my retirement lifestyle was more expensive than the one I described above. I liked first-class travel, five-star hotels, and fancy cars. My yearly net was close to $500,000 - after taxes. To generate $500,000 in after-tax dollars, I would have had to earn $900,000 in passive-interest income on that $5 million. That represents a return of 18%. I understood enough about stock market performance to know that was impossible. I should have cut my expenses drastically. But I didn't want to. I enjoyed the lifestyle I had. I was still a big spender. So I had no choice. I had to go back to work! I put the word out and got a few offers. A month later, I was back at work. I half expected to feel miserable, toiling away again. But the moment I started earning money again, I started to feel better. How Retirement Should Feel Retirement isn't supposed to be about money worries. Yet, if you retire with too little, that is exactly what you will get. Trying to get above-market returns is very challenging under any circumstance. But when you have to get high returns to pay the bills, it can be extremely stressful. As I write this, millions of people my age are quitting their jobs and selling their businesses. They are reading financial magazines and subscribing to newsletters. They are hoping to find a stock-selection system that will give them the 20% and 40% returns they need. But they will find out that such systems don't exist. They may have a few good years, but eventually the returns they get, will drop to 10% or less. Or there will be another stock market crash. Or inflation will rise dramatically. At that point, things will get bad fast. But it doesn't have to be this way. Let's go back to the example of the couple hoping for a consistent 20% return to keep up their retirement lifestyle. That is, as I said, highly risky. But if they got part-time jobs that gave them an extra Rs 1-2 lac in active income each per year, that would make their retirement dream very reasonable . I am not saying that you should give up on the idea of retirement. I'm saying that you should think of retirement differently. It is a wonderful time of your life when you change the ratio of work and pleasure. Instead of spending 80% of your days working for money and 20% having fun, you spend 20% of your time working and 80% having fun. That doesn't seem so bad, does it? And if you are smart about what kind of work you do, you can actually have fun working! Paint a new mental picture of what retirement can be: a life free from financial worry that includes lots of travel, fun, and leisure - funded in part by active income from doing some sort of meaningful work. There are many ways for a retired person to earn a part-time, active income. You could do some consulting, start your own Web business, or earn money doing any sort of purposeful work. How much active income do you need? That's easy to figure out. Determine what you need to spend each year for your retirement. Determine how much money you will have in your retirement account. Assume that you get no more than a 10 - 15% yield on your retirement account. Subtract C from A. That is what you need to earn. The first benefit of including an active income in your retirement planning is that you will be able to generate more money when you need to. But the other benefit - the one that no one talks about-is that it will allow you to make wiser investment decisions. This is an important point. When you are a slave to ROI, you will feel pressure to invest in higher-risk propositions. A few of these might work out well. But most of them will disappoint you. Some terribly. Making a 10% or even 15% return on your retirement account is easy to do safely. But trying to make twice that much - that is something you don't want to do. By Mark Ford