Imagine receiving a $200,000 windfall, perhaps through an inheritance, lottery winnings, or even a failed lawsuit in your favor.
It’s a scenario Devon faces. At 45, he has found himself with a nice shot of $200,000 in his arm, allowing him to look forward to a more comfortable retirement than he otherwise would have had. But it has also filled her with some concern about the best next steps.
She doesn’t think she’s particularly financially savvy and hasn’t done much in the way of saving for retirement. In fact, she hasn’t done anything at all. But now, with the boost of several hundred thousand dollars to his retirement fund, he’s actually doing better than many Americans his age.
That’s because in 2022, the median retirement savings account balance among Americans ages 45 to 54 was $115,000, according to the Federal Reserve (1).
Since Devon doesn’t plan to retire for two decades, this also gives him the benefit of spending time on his investments.
Additionally, while many people aim to retire at age 62 (because that’s the youngest age to enroll in Social Security), if Devon can delay his retirement until age 67 as he plans, he’ll be able to get additional benefits.
That’s because filing at age 62 will mean accepting a reduced monthly benefit for life, even if it means starting retirement earlier, as a good number of seniors are willing to do.
Another disadvantage Devon avoids is that you won’t need to rely on your retirement savings for as long as someone who retires at age 62 (experts suggest planning for 25 to 30 years).
So this is where the Devon portfolio comes into play, especially if it is set up to generate passive income.
But how realistic is it to turn $200,000 today into $100,000 a year in passive income 22 years from now, assuming no additional contributions? Let’s find out.
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Since 1926, the stock market has produced about an average annual return of 10%, representing years of strong performance as well as recessions. (2)
So, let’s say you have $200,000 to invest today at age 45, and your goal is to retire at age 67. While it’s fine to invest heavily in stocks for, say, the next 15 years, as retirement approaches, it’s generally smart to cut back on stocks and move into assets that are more stable, like bonds.
Because of this, we cannot assume that a $200,000 investment today will generate a 10% return over the next 22 years. A smarter approach is to assume something more modest, say a 7% yield, to be safe. If that $200,000 earns 7% over the next 22 years, it will grow to about $886,000.
So now let’s get back to that goal of $100,000 a year in passive income. If that $886,000 portfolio is your only source of assets, then frankly, it may be difficult to come up with $100,000.
Today, you can expect a dividend yield of about 1.17% from a portfolio of the S&P 500. (3) But let’s say that instead of investing in an S&P 500 ETF, you specifically put together a portfolio full of stocks that pay remarkably high dividends.
Still, an average return of 5% would be generous in that situation. And at $886,000, then you’re looking at about $44,000 in passive dividend income.
Of course, this all depends on what Devon’s definition of passive income is. If you include Social Security, you may be reaching your $100,000 goal.
Devon would receive a fairly generous monthly Social Security benefit (also because he would have avoided the reduction for filing early).
Here’s how the math breaks down:
In 2025, the maximum Social Security benefit at full retirement age is $4,018 per month. (4)
If we assume that in 22 years it will be $5,785 a month (this figure depends on inflation increasing to a target of 2% annually between now and then), and then multiplying that by 12, Devon will receive about $69,430 a year from Social Security.
With another $44,000 in dividend income, he would make just under $113,500 a year, a bit more than his goal.
And of course, $113,500 a year is not a bad retirement income. In 2023, American consumers spent an average of $77,280, the Bureau of Labor Statistics reports. (5) But it is common for retirees to spend less than the typical consumer, so Devon’s projected retirement income suggests a comfortable retirement, given what we know.
However, on the other hand, one of the biggest risks to your retirement income is inflation. In recent years, it has been quite rampant.
We do not know what inflation will be like in the coming decades. But any passive income Devon’s portfolio generates could lose value if living costs rise substantially.
Fortunately, Social Security benefits are eligible for an annual cost-of-living adjustment. You may still need to make changes to your portfolio in retirement to account for a faster pace of inflation should that scenario arise.
If you’re in the process of building a retirement portfolio, it’s best to give yourself a longer investment window, like Devon plans to do. But no matter how far away retirement is, you’ll need to ask yourself what strategy you want to employ.
Some investors like to focus on value stocks, which tend to produce higher dividends. However, value stocks tend to experience slow, steady growth, rather than explosive growth.
Other investors prefer growth stocks, which, as the name suggests, focus on rapid growth. Growth stocks tend to pay minimal or no dividends. And the reason is that these companies prefer to invest their profits in their businesses rather than share the wealth with shareholders so that their stock prices can skyrocket even more.
There really is no strategy between good and evil. You can grow your portfolio with value or growth stocks, or both at the same time. But you should know that while growth stocks can be a suitable investment during your wealth-building years, they can also be more volatile than value stocks.
As such, you may want to focus on value stocks in retirement, both for the relative stability and the income they tend to produce.
Of course, when retirement comes around, it’s also important to keep stable assets, like bonds, in your portfolio to protect against market volatility. But the good thing about bonds is that they also generate great income.
So if you’re focused on passive income, a mix of bonds and value stocks with strong dividends could set you up for a comfortable lifestyle, especially if combined with a fairly generous Social Security paycheck.
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Federal Reserve (1); Covenant Wealth Advisors ((2)(https://www.covenantwealthadvisors.com/post/how-average-stock-market-returns-can-fail-investor-expectations)); Y Charts (3); Social Security Administration (4); Bureau of Labor Statistics (5)
This article originally appeared on Moneywise.com with the title: I am 45 years old and I want to invest a sum of $200 thousand so I can retire at age 67 with $100 thousand a year. Should I focus on dividends or growth?
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