We all know about the importance of investment diversification, especially it comes to retirement planning—today I’d like to focus another type of diversification, one that’s even broader in scope. It’s income diversification, and it could quite possibly be the most neglected part of retirement planning. It includes all sources of income, including business income.
With investment diversification you’re looking to create a portfolio that has the right mix of mutually exclusive investments that will improve performance by lowering risk. Fair enough. Income diversification is the process of creating income streams from several sources which not only increases cash flow, but also lowers the reliance (risk) on any one of them.
With retirement, this can be done with investment earnings and Social Security, but if you want to create a third income source, you can do it through a retirement business.
It’s even entirely possible that an income stream from a business may provide a more secure retirement than a large nest egg (more on that later). And the combination of a business and a nest egg and Social Security may provide the best retirement plan possible—especially if your retirement savings aren’t where they need to be. It’s something to plan for.
A Million Dollars is A LOT of money!
Let’s cut to the chase—in order to fully retire, and have enough income to pay your living expenses, and have enough money to cover contingencies, and have some left over to continue to grow your investments so they don’t get wiped out by inflation—you’d have to have at least a million dollars saved up at retirement. More probably two or three million, given inflation. I’m just being realistic here—it truly is a tall order.
Do you think you can do it? If not, you need to be making other plans.
Holes in traditional retirement planning
While it is possible to save up a million dollars (or even more) over 30-40 years, it won’t happen for most people—that’s a statistical fact. Investment models produce pretty results, but let’s face it, life doesn’t always cooperate with our plans!
Here are a few examples:
- Assumed rate of return on investment (ROI) may not support projections
- In the pursuit of an ROI that will support our retirement needs we may take on too much risk and get burned for the effort
- A future stock market crash could nullify years of retirement savings especially if it happens near or during retirement
- People DO make investment mistakes; so do financial advisors—we’re all human
- Job instability may lead to erratic retirement funding
- Long-term unemployment means retirement isn’t being funded
- The unemployed are often forced to draw down retirement savings
- Interest rates on fixed income investments are far too low to provide a viable alternative to equity investments in volatile or falling markets
In the financial world it’s an article of faith that we can invest to cover what ever needs we’ll have in retirement but little is said about the real life that takes place between now and then and often gets in the way of the best laid plans. In looking at the list above it’s unlikely we’ll be able to invest around any one of these, let alone a combination of two or more.
The ultimate reality is that life is not perfect and for that reason alone we need to have back up plans.
Creating business income streams may be more important that retirement savings
That reads like an exaggeration, but here’s why I feel confident in saying it: it takes a lot of money to create income streams from investments. For example, the convention on the “safe rate of withdrawal” on retirement assets is 4%–you can withdraw 4% of your investment value each year and still maintain the value of your investments. I think that’s more of an assumption than it is a convention.
If you withdraw 4% for living expenses, and inflation is running at 4%, you’d have to earn 8% on your investments in any given year. With interest rates hovering around 1%, that pretty much means you’ll need to have most of your money in the stock market in order to accomplish that (see items #2 and #3 in the previous section). Can you really do that?
To take it a step further, let’s say you project a need for $40,000 in investment income in retirement—how much money will it take to “buy” that income stream? One million dollars. Again, that’s a lot of money, and most people are unlikely to have it. And, thanks to inflation, the further you are from retirement, the bigger that number will be.
A “retirement business” to the rescue
A business is dynamic—the income from it will adjust to what ever future price levels will be. You can grow it through your own efforts. It doesn’t depend on the ebb and flow of interest rates or of the performance of the financial markets. And it won’t require a million dollar investment!
That last point is critical. You can create a $40,000 income from a business without putting more than a few hundred or a few thousand dollars up front. That’s truer in the Internet Age than ever. The growth will be driven by your time, effort and talent, not by your capital contributions. Best of all, when you’re finally ready to move from semi-retirement into full retirement, you can sell your business and have more money to add to your nest egg.
What kind of business?
This is really the foundational question. You probably don’t want it to be related to what you’re now doing for a living, but rather something you can enjoy. Think about a business you’ve always thought of having—maybe your dream business. Retirement should be a time to pursue dreams that weren’t possible earlier in life—seize the opportunity!
On a more practical level, here are some criteria to consider:
- The business shouldn’t be capital intensive—it should be skills-driven and thus easier to grow and to leverage
- It should be a business that you have the talent, desire and skills for—or the willingness to acquire them
- It should be a business that doesn’t have age restrictions
- It should be a field that has room for growth (avoid declining industries)
- It should be in an industry that affords a lot of flexibility and is driven by innovation (rigid industries are usually the ones that work purposefully to limit competition)
- If it’s the kind of business you’d like to have even if you didn’t make any money doing it, you’re probably looking in the right place!
Here’s my real life example…I always wanted to be a writer, but 20 years ago when I first gave it a try I found it impossible to get past the “gate keepers” who kept tight control over the industry. I spent most of the years since working in the mortgage business—and everyone knows what happened in that industry. I exited at the end of 2008.
But something was different in early 2009 then it was in the early 1990s—we now have the internet and writers are needed all over the place. Goodbye gatekeepers, hello opportunity! I’ve been running this blog and freelance blog writing for others, and while I’m not getting rich (yet!), I am making a living. And that’s in under three years (2.5 this month to be exact!)
You can do the same. It requires a certain relentlessness, but it IS doable.
What about my retirement—do I ever kick back and enjoy a life of blissful nothing?
Here’s something I learned both from having my own business and from knowing dozens of small business owners during my public accounting career: the self-employed seldom want to retire as much or in the same way that salaried people do. I’ve known many self-employeds who have worked into their 70s and even 80s.
Employed people sometimes “put in time”, which is especially true in the last years before retirement. Self-employed people don’t sense the imperative to retire at all. If you own the business, it’s a part of who you are and you aren’t so anxious to abandon it. You also have the option to ratchet things down a bit, to take it easy if you choose. I have a lot of self-employed friends and the topic of retirement seldom comes up. Maybe it’s because they see it as quitting on themselves. Taken that way, retirement can and does look a lot different.
If you start running your own business there’s an outstanding chance you’ll feel the same way.
How do you make it happen?
How do you create your own business? One step at a time is always best. If we’re talking about a business you’ll have in retirement, the process will be even easier. Since you probably have years before you retire, you can start a business now as a hobby business and grow it over the years just as you would a retirement portfolio.
Don’t put this off however, thinking that you can wait and do it a year or two before retirement. A business isn’t like a job that begins providing an income immediately; it could take years to reach that point. Also, your first effort could fail and you’ll need time to try again (and still again if necessary!).
Another important point: since you want any retirement business to be on the easy side, the sooner you begin, the more time you’ll have to fine tune the business and become “accomplished”. When you reach that level, businesses are often easy, or at least easy–er–and they blend a lot better with semi-retirement.
Have you considered starting a “retirement business”? Do you agree that this could be a viable option for people who have inadequate retirement savings?
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