Should you build up a hefty nest egg or multiple passive income streams for the most stress-free retirement? Both have their upsides and downsides and the right choice really depends on who you are as a person and investor.
In this post we'll dive into how each method of financial independence works and which one suits you more. Also, I'll be revealing which concept I, personally, like better. Let's get right into it!
How Does a Nest Egg Retirement Work
A nest egg retirement is the method which MOST people who partake in the financial independence journey implement. Put very simply, it's when you build up a chunk of money big enough that you can invest it into the stock market (or other markets), take out a safe withdrawal rate (SWR) every year, and have that be enough to cover your expenses.
Let's say that I have $1,000,000 saved up as my nest egg. Theoretically, I could put that million dollars into the stock market and it should (on average) return at least 7% a year. Then, I could withdraw 7% every year without having it impact my principle. This allows me to make $70k every year from my nest egg, so as long as my expenses are below that… I'm retired!
In reality, though, the stock market will bob up and down, so a good safe withdrawal rate is really like 4%, with some people citing a conservative number even LOWER than that.
For most people, they reach this number by consistently investing in the markets for a long time. If you make 100k every year and save 30% of your income into the stock market, it'll take you around 17 years to reach 1 million dollars. Still, this is a method that most FIRE participants choose. Once they hit their FIRE number, they are free to retire and do whatever they want in life as they can live off that nest egg for the rest of their lives.
The Case for Nest Eggs
The best thing about nest eggs is that they are simple. It intuitively makes sense to save up a large sum of money over time. That's how traditional retirement plans are conveyed to kids in school. “You just need to save up a large enough sum of money for you to retire.”
Another upside is that traditionally… it works! Not only that, but it works for most people who stick with it for long enough. If you consistently invest your money into the global markets over a 30 period time frame, it'll be hard for you NOT to walk away with a hefty egg big enough to support your retirement.
Building up a nest egg is the classic, safe way to retire. And everybody loves the classics.
How Does a Passive Income Retirement Work
A passive income retirement works a little differently from a nest egg. Basically when you build up passive income streams, you are building/acquiring/managing assets which will produce for you money every month which you can spend.
Usually this will come in 2 forms:
- Real estate rental income
- Business income
Let's say you buy a property that manages to cashflow you $200 a month. What that means is that every month you will receive an extra $200 to spend, PLUS at the end of 30 years, you'll have a fully paid of house. All you need to do is acquire enough of these properties to fully cover your expenses…. and you'll be retired!
There are SO many ways to build up passive income that it's impossible to describe every single one here, but usually some kind of business endeavor is involved. Even with real estate investing, you're still technically running your own tiny business.
BECAUSE there is more variance and risk though, the rewards are much higher…
The Case for Passive Income
The most telling upside of trying to build up passive income is that (if you succeed), you will often retire much earlier than if you were to try and build up a nest egg.
Someone doing real estate investing really only needs to get 2-3 properties to be able to retire. And acquiring those properties is hard, but shouldn't take that long.
In the same way, many many businesses fail before they even release their first product. But think about all the successful businesses which have CEOs making TONS of money before they even turn 30.
If you're feeling a bit ambitious, passive income is definitely the way to go. It'll test your nerve and endurance, but if you end up “winning” at your game, you will be rewarded handsomely with early retirement.
Which One Am I Gunning for More?
Honestly, as an ambitious and very type A person, I personally prefer the passive income stream path as opposed to the nest egg path.
The thing with passive income streams is that you aren't losing any equity in the process. While you are receiving checks from your rental units, you're ALSO paying down the mortgage. While you're receiving money from the business, you ALSO have the ability to sell it for a multiple of it's income.
Also, for businesses and real estate, you can use leverage. What that means is that you can use OTHER people's money to help create your own wealth. This simply isn't possible for building you're nest egg. It doesn't make sense! Can you imagine going to the bank and saying “I'd like a loan of $800,000 so that I can dump it into the stock market”?
Of course, it's not easy to start a business or invest in real estate. Which is why I still see the merit in building a nest egg. It's the safe way! There's really no way you can mess up making more money, cutting your expenses, and saving the difference for an extended period of time.
Start Planning for Retirement
For many, retirement seems like a far away dream. The thought that they could possibly not have to work and instead live life on their own terms is a dream.
BUT, these 2 methods enable almost anyone to retire with the life they want:
- Nest Egg
- Passive Income
Personally, I prefer the idea of building passive income streams over building up a nest egg. Partially for time reasons (you can retire faster building passive income), but also I like to be more hands-on with my finances.
Regardless of which you choose though, it's important that you take action. AND take action early. So get out there and start learning more, start saving away money, and start investing for your future. I promise retirement you won't regret it.
Jeff is a current Harvard student and author of the blog Financial Pupil who is passionate about learning, living, and sharing all things personal finance-related. He has experience working in the financial industry and enjoys the pursuit of financial freedom. Outside of blogging, he loves to cook, read, and golf in his spare time.