How to Invest for Retirement

One of the biggest problems facing investors nearing retirement is how to invest their money in such a way that they will have the capital needed to fund their golden years.

This has become even more difficult thanks to the current low interest rate policy established by the Federal Reserve. Conservative investments like bonds and bank instruments simply no longer provide the return necessary to fund retirement.

Many investors are also reluctant to turn to the stock market as well. The past 12 years have seen two horrendous bear markets that destroyed many hopeful retirees' nest eggs, delaying retirement for several years.

Most mutual funds have underperformed the somewhat minuscule returns offered by the market the past ten years, and many of the specialty products offered by Wall Street have featured poor performance and very high fees.

And asking for solid, reliable advice on how to invest, without paying a fortune for the input, has been extremely difficult.

As a result, many investors approach the road to retirement with trepidation.

A look at history shows us that there is a viable approach when deciding how to invest for retirement, an approach that can help you earn the returns to grow your nest egg today and provide the income you need later.

How to Invest for Retirement: Get Paid to Outperform

Rather than using index funds or other suggested strategies, investors should focus on dividend growth.

A look at dividend growth mutual funds shows that they have not only outperformed index funds over time, they also lose far less when the market inevitably head south.

The idea is not to buy the highest yielding stocks at a moment in time but those with the capacity to grow their dividends at a high rate going forward. The higher dividends over time tend to promote a higher stock price and provide a cushion in a bear market.

Retirement-oriented investors can improve their odds by adding some common sense valuation parameters.

A look back in history shows that even in the difficult 10-year period we have just endured, buying stocks with a strong capability to raise their dividends and trade at less than 15 times earnings and two times book value has provided solid returns.

Take this example...

In 1998, a 50-year-old considering retirement in 2013 would have seen his money grow at 11% per year if he applied those parameters to the universe of larger stocks followed by the Value Line Investment Survey.

Over the past ten years, index fund buyers have earned a return of just about 2% while this approach has returned more than five times that approach.

There are some keys to making this approach work for you as you look out towards retirement.

The first is to look at the sectors you're invested in.

If we compile a list of stocks that fit our criteria, the list is dominated by bank stocks. This makes sense as banks are well positioned to restore and increase dividends as the credit problems of the past fade away - but the last thing we want is a portfolio of just bank stocks.

The list also contains food distributors such as Coremark Holding Co. Inc. (Nasdaq: CORE), high tech companies like Cisco Systems Inc. (Nasdaq: CSCO), insurance companies like Lincoln National Corp. (NYSE: LNC) and many other sections in a wide range of industries. It is okay to have a few banks stocks or utilities but you should include other sectors as well.

Another key to making the dividend growth approach work is to take a long view (requires patience!).

You are investing this money for the next decade or longer, so there is no need to run out and invest the money right away. Although it may not seem like it after 2013's strong start, markets do go down sometimes. You want to buy weakness in the market whenever possible.

The same applies to reinvesting dividend payments over the years. Let them pile up until the market experiences one of the inevitable selloffs you will experience over a decade.

Another part of taking a long view is not checking your stocks daily and fretting over price movements. They will go up and down with the market but you are more concerned with the price ten years from now than the price today.

About every six months or so you need to review your account. Sell and replace any stocks that have eliminated their dividend or appreciated too far too fast and trade above a 15 PE or more than two times book value.

Beyond that, let time work for you and ignore the day-to-day fluctuations of the market.

Focusing on undervalued stocks with the potential for strong dividend growth is a sound conservative strategy when considering how to invest for retirement. These stocks tend to outperform in both up and down market cycles and can help ease the path to the golden years.

For more tips on how to invest for retirement, check out this story on how to plan your needed savings amount: A New Blueprint for Retirement Savings