Americans are increasingly responsible for planning their own retirements as pensions gradually go extinct. Combine that with longer life expectancies and weaker Social Security benefits, and many Americans worry they’ll run out of money in retirement.
Although retirement has changed dramatically over the last 25 years, you have more resources than ever to help you plan your retirement safely. And the greater your financial literacy, the greater the odds of a wealthy retirement.
With even a basic understanding of the following investments, you can plan your retirement with confidence.
A Quick Overview of Tax-Sheltered Accounts
Before diving into actual investments, it’s worth mentioning that how you hold your retirement savings and investments matters nearly as much as what you invest in.
Uncle Sam doesn’t want you out on the street in your dotage years. To both incentivize you to save and reduce your tax liability, the federal government offers a range of tax-advantaged accounts to invest your nest egg.
They start with individual retirement accounts or IRAs, which you open and control yourself (rather than being administered by your employer). If you don’t already have one, review our list of the best IRA account brokerages to help you choose.
Traditional IRA contributions are tax-deductible for an immediate tax break. You must pay taxes on withdrawals in retirement, however. Roth IRAs don’t come with an initial tax deduction, but they grow and compound tax-free. You pay no taxes on withdrawals from them in retirement.
Unfortunately, the IRS sets a rather low limit on annual contributions to these accounts. In 2021, you can only contribute $6,000 ($7,000 if you’re over 50). You can split your retirement contributions between traditional and Roth accounts if you like.
These accounts come with far higher contribution limits, but not necessarily the same breadth of investment options. If your employer offers matching contributions, take full advantage of them, because they’re effectively free money.
Consider maximizing each retirement dollar you invest by doing so with a tax-sheltered account, keeping more money in your own pocket and out of Uncle Sam’s.
Best Investments for Retirement Planning
The following represent the most common investments, although not every one is appropriate for everyone. Again, the greater your financial literacy, the better equipped you are to make your own sound investing decisions.
When in doubt, err on the side of simplicity.
1. Exchange-Traded Funds (ETFs)
Exchange-traded funds (ETFs) are portfolios that hold hundreds or even thousands of different stocks or bonds. In that sense, they work like mutual funds, but unlike mutual funds they trade in real time on public stock exchanges.
Also unlike mutual funds, ETFs tend to be passively managed, rather than actively managed by a fund manager (as most mutual funds are). Often these funds simply mimic major stock market indexes like the S&P 500 — hence the term “index fund.”
Because they aren’t managed by a highly-paid fund manager, ETF administrative costs are low — often a tiny fraction of the cost of administration for an actively managed portfolio, such as a mutual fund.
ETFs are particularly useful in retirement portfolios as an easy way to diversify your asset allocation.
As useful as index funds are, however, you can invest in other types of ETFs as well. Options include funds focused in a certain country or region, small- or large-cap stocks, different industries, socially conscious investments, or high-dividend stocks, just to name a few.
For that matter, ETFs don’t have to own stocks at all. Other types of ETFs own bonds with varying maturities or ratings of corporate and government debt; commodities such as gold, silver, and palladium; or world currencies.
Pro tip: You can earn a free share of stock (up to $200 value) when you open a new trading account from Robinhood. With Robinhood, you can customize your portfolio with stocks, ETFs, and crypto, plus you can invest in fractional shares.
2. Target-Date Funds
While mutual funds have largely fallen out of favor in recent years compared to less expensive ETFs, one type of mutual fund makes particular sense for retirement planning: target-date funds.
You pick a fund based on the year (or range of years) you plan to retire. The fund manager picks investments that make sense for someone retiring that year, changing the investments as the target year approaches.
This is necessary because the less time you have between now and retirement, the less risk tolerance you have. So fund managers gradually move these funds’ assets out of high-risk stocks and into lower-risk investments as the target date approaches.
You can leave your money in these funds after retiring as well, knowing that the manager continues optimizing for risk.
If you just want a single, “set it and forget it” retirement investment, target-date funds make a reasonable option.
3. Individual Stocks
No one says you must invest only in diversified funds like ETFs and target-date funds. You can also pick and choose individual stocks if you like.
For example, many retirees like high-dividend stocks, such as dividend aristocrats — companies that have increased their dividend every year for at least 25 years. These stocks tend to pay high yields and have demonstrated consistency over time.
Other investors follow stock picking services, such as Motley Fool’s Stock Advisor, in an effort to beat the broader market’s returns. Just beware that picking individual stocks to chase higher returns adds risk to your portfolio.
Pro tip: Before you add any NASDAQ companies to your portfolio, make sure you’re choosing the best possible companies. Stock screeners like Trade Ideas can help you narrow down the choices to companies that meet your individual requirements. Learn more about our favorite stock screeners.
Bonds make up the classic refuge for retirees, with their lower perceived risk and steady interest payments.
A bond represents a loan to either a government or a corporation whereby the borrower agrees to pay you regular interest until repaying your investment in full (maturity).
Bonds are rated for credit risk (likelihood of default) by independent credit rating companies such as Standard & Poor’s and Moody’s, the best rating being AAA or Aaa, respectively.
Bonds usually trade in units of $1,000, with the face-value amount being denoted as “par.” The interest rate is fixed at the time of issuance and remains unchanged throughout the life of a bond.
But you don’t have to buy new bonds directly from the issuer. You can buy bonds on the secondary market from other investors.
Market values of bonds vary according to the bond’s interest rate and the prevailing market interest rates at the time of the valuation. This variation is called “interest rate” risk.
In order to minimize interest rate risks, astute investors utilize “bond ladders,” an investment scheme that staggers bond maturities so that a portion of the portfolio matures each year and can be reinvested at the then-current rates.
The major advantage of bonds and similar fixed-rate instruments is that you know the interest rate when you buy them, and you get your original money back upon maturity
Treasury bonds and bills issued by the United States government are considered the safest investments in the world, with virtually no credit risk.
Some bond issuers, such as states and municipalities, offer tax-free interest payments. In these cases, you don’t have to pay income taxes on the interest you earn, which boosts your effective returns — particularly if you’re in a high tax bracket.
Just don’t buy these bonds in a tax-sheltered retirement account because the tax benefits would be redundant.
Unfortunately, interest rates have been so low for so long that bonds just haven’t paid well in recent decades. That makes it far harder to survive on bond payments alone.
Think of annuities as insurance against superannuation — running out of money in retirement.
Annuities are payment contracts between an insurance company and the policyholder: you.
They guarantee a specific or variable return for your invested capital, and make payments to you for a specific length of time, or even your lifetime. Payments can start immediately or be deferred until retirement or later.
You can structure an annuity to resemble a fixed-income investment like a bond. Or you can structure it like an equity investment where growth varies based on the performance of a security index, such as the S&P 500.
You can buy annuities from most investment brokers including TD Ameritrade.
Annuity holders enjoy tax-deferred growth of the principal until distribution. Most importantly, there are no limits to the size of annuity you can purchase, unlike the annual limits to an IRA or 401(k). Because of their inherent tax advantages, you typically don’t buy annuities in a tax-sheltered account such as an IRA.
You can structure annuities however you like, and can even include survivor benefits. Distributions are a combination of returned capital (tax-free) and growth (taxable), effectively increasing the net income you receive with each distribution.
Disadvantages include purchase commissions that can be as high as 10%, onerous surrender charges if you take withdrawals earlier than initially contracted, early withdrawal penalties and taxes if you withdraw prior to age 59 1/2, and high annual fees.
6. Publicly Traded REITs
Real estate investment trusts (REITs) operate similarly to ETFs, except they own a portfolio of real estate instead of stocks. They may own apartment buildings, or office buildings, or any other type of real estate.
One variation, mortgage REITs or mREITs, own loans secured by real estate rather than directly owning properties.
Like ETFs, REITs trade live on stock exchanges. That makes them extremely liquid unlike most real estate investments: you can buy or sell them instantly. It also makes them more volatile than most real estate investments.
One quirk of REITs is that the U.S. Securities and Exchange Commission (SEC) requires them to pay out 90% of their profits each year to shareholders in the form of dividends.
While that creates high dividend yields, it also means REITs have little ability to grow their portfolio. That limits their share price growth potential.
7. Real Estate Crowdfunding
A relative newcomer, real estate crowdfunding investments offer another way to invest in real estate indirectly.
Some of these work like REITs, as a pooled fund that owns properties or mortgage loans. You buy shares of these REITs directly from the company, however, rather than on public stock exchanges.
Most expect you to leave your money invested long-term and penalize you for selling early. That makes shares much less liquid than their publicly traded counterparts. Strong examples include Fundrise, Streitwise, and DiversyFund.
These private REITs also fall under different SEC regulations and can reinvest their profits to buy more properties or loans. That boosts their growth potential but means you may not collect high dividends in the short term.
Other real estate crowdfunding platforms don’t operate like REITs at all. For example, Groundfloor lets you pick and choose individual loans to fund, each with its own interest rate. Because these are short-term hard money loans, you get your money back in months rather than years, when the borrower repays the loan.
8. Rental Properties
Not everyone should invest in rental properties. They require knowledge and effort to buy and manage over time. But for anyone with a passion for real estate, rental properties come with some unique advantages for retirement income.
First, they generate income forever — income that only goes up over time as the rent rises to keep pace with (or surpass!) inflation, even as your mortgage payments remain fixed.
That makes them a great investment to protect against inflation. And that mortgage payment eventually disappears as your tenants pay down the balance for you.
Rental properties also come with tax advantages. You can deduct every tangible expense plus some intangible expenses like depreciation.
The returns are predictable. You know the market rent, know the purchase price, and can accurately estimate all expenses over the long term.
But rental properties also come with significant downsides, even beyond the aforementioned labor and skill required. They’re notoriously illiquid — it takes time and money to buy and sell them.
They also cost a lot, to put it mildly. Even when you take out a mortgage, you can still expect to put down at least 20%, which means tens of thousands of dollars invested in a single asset.
Which in turn makes it difficult to diversify, when so much of your capital sinks into each individual investment.
Only consider rental properties if you have a true passion for real estate, and are willing to treat investing in it as a side hustle.
The investments outlined above are far from your only options. You can get creative and explore unorthodox retirement strategies, to potentially earn higher returns.
But even if you do, stick with index funds, bonds, and possibly real estate as the core of your retirement plan. They’ve stood the test of time, making them a reliable source of income for your golden years.
If you don’t want to hassle with managing your retirement investments, outsource it to a robo-advisor or human financial advisor if you have a high net worth. They manage your asset allocation and rebalance it automatically — all you have to do is add money with each paycheck, which you can automate with recurring payments.
As a final thought, no one says you have to wait until the traditional retirement age of your 60s to retire. With enough passive income, you can reach financial independence and retire at any age.
Get serious about investing and building wealth now, and it opens endless possibilities for how you spend your remaining decades.