Why Millennials Should Focus on Income Replacement Before Asset Appreciation

Millennials have been dealt a rough financial hand. Concerns around student debt, job instability, wage stagnation, and inflation are only some of the major issues they’re facing. And to handle these financial problems, millennials will need to develop new solutions—and perhaps entirely rethink their approach to wealth-building if they want to be able to retire on time. 

Thankfully, all is not lost. Although the economic conditions are much different from what they were in the 20th century, there are strategies millennials can use to approach financial independence with confidence, such as rethinking where to contribute their retirement savings. 

In this article, we’re going to focus on an important wealth-building strategy millennials can use to help them catch up from the financial challenges they’ve faced in past decades: income replacement. By focusing on replacing income first, and then asset appreciation, millennials may be able to build wealth more effectively. 

Why Is Income Replacement So Important for Millennials?

By income replacement, I’m referring to passive income that replaces your active income, or the income you work for directly (i.e., your job or career). In other words, you can think of active income as “trading time for money.” While you may be able to increase your earning potential, there’s only so much time you can spend earning. At some point, you’ll tap out.

With steady streams of income flowing in from passive sources, you can continue to earn more securely in retirement—or even before retirement—without having to put more time into work. 

And speaking of retirement, millennials are looking to retire earlier. This trend coupled with longer life expectancies poses a huge need for income replacement. Because the longer you live without working, the more money you’ll need to maintain your health and lifestyle. 

It’s not just a longer retirement that makes income replacement vital. There’s also the increasing job instability millennials are facing. This, coupled with frequent career changes, can translate to periods with no actively earned income. Having an income replacement strategy in place can help millennials continue growing (or maintaining) the wealth they’re building despite life and economic transitions.

Income Replacement vs. Growth Assets

Millennials’ lifestyles and challenges underscore the importance of an income replacement strategy. But even without those challenges, current and future projected economic conditions are making it harder for individuals to build enough wealth that provides a secure, even modest income for retirement. 

Most investors are familiar with traditional assets like stocks, bonds, ETFs, and mutual funds. And there's a good reason for that. Assets like these have been a reliable way to build wealth in retirement for generations as they historically appreciate over time. 

Mutual funds, for example, allow you to take advantage of compound interest during your working years. Then once you’ve built a nest egg, these traditional assets provide retirement income in the form of interest and dividend payments. 

But the bankability of these traditional approaches being enough on their own is fading. Inflation, market volatility, and outdated withdrawal strategies make it incredibly difficult for most people to save enough for these investments to produce even a modest reliable income in retirement (see example below).

Common income-producing assets include real estate, self-storage, equipment leasing, peer-to-peer lending, private equity, and many more. Income-producing assets provide income on an ongoing basis, often in the form of rent checks, lease payments, or interest payments. While these assets may also appreciate over time, they offer investors the peace of mind of reliable, consistent income on a monthly, quarterly, or annual basis. 

The Benefits of Income-Producing Assets

To build wealth effectively in today’s economic environment, it may be worthwhile for millennials to invest in income-producing assets before they invest in traditional growth assets—or at least to strike a balance between the two. 

While I’m not recommending an investment strategy that solely focuses on income-producing assets (income-producing assets come with their own inherent risks), I do think millennials will be able to produce more income for themselves in retirement with less capital than if they only invest in traditional assets like stocks and bonds.

For example, to produce a retirement income of $100,000 a year, investors would need to save a principal balance of $2,500,000, assuming a 4% annual withdrawal rate (which again, may be outdated). While a retirement nest egg of this size is in reach for the wealthiest of millennials, it’s not realistic for most others.

But with an income-producing asset like real estate, it may be possible to produce an annual income of $100,000 with a lot less capital invested. We believe an income return benchmark for real estate investments should be around 10%. Although this benchmark may sound unattainable to conservative investors, it isn’t unrealistic. With this kind of return, you would only need a principal of $750,000 invested in real estate to generate $100,000 a year in retirement.

How to Invest Retirement Savings in Income-Producing Assets

To invest retirement savings in many alternative, income-producing assets such as the ones listed above, you’ll likely need a special retirement savings vehicle to do so: a self-directed IRA. Regular IRAs, 401(k)s, and other retirement accounts simply aren’t set up to invest in these kinds of assets.

Plus, investing tax-advantaged retirement savings in alternative assets can be tricky from an IRS-compliance standpoint. At Chicago Trust Administration Services, we provide custodial services for self-directed IRAs to help investors make fast, IRS-compliant transactions in alternatives assets. 

We take pride in helping to educate future generations on how to build wealth, and have been helping individuals and families invest in alternative income-producing assets for over 17 years. Part of what has allowed us to serve clients with integrity for so long is our ability to adapt to the modern market’s challenges.

Right now for millennials, there are major barriers to financial independence. But luckily, new strategies are emerging so millennials can still plan for a rewarding retirement. If you’d like to learn more about how to invest in alternative assets as a way of meeting these challenges, we’re here for you. To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.

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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.