How to Retire With Absolutely Nothing

My friend's mother, Paige, is a swell lady. She's loving, devout, and embodies the virtue of hope.

But she is a horrible investor -- and because of that, she's now living a nightmare of a retirement.

Bypassing all "yo momma" jokes ...
Rewind to the past: Paige grew up as the daughter of a wealthy architect. Needless to say, she never lacked anything. And her father, being the astute businessman that he was, obsessively invested any extra cash he had in the stock market. Upon his death, this massive portfolio of stocks was divvied up between his three children.

Fast-forward to the present: Despite that inheritance, Paige lives in a tiny duplex she rents, relying for her income solely on a monthly Social Security check. She has no savings.

What went wrong?
No, the stocks she inherited didn't plummet. No, she doesn't have a proclivity for gambling. And no, she was never the object of a massive burglary.

But she never planned for retirement.

I discussed Paige's situation with our retirement expert Robert Brokamp, advisor of the Rule Your Retirement service, and he pointed out three critical mistakes she made -- mistakes that you, in turn, should avoid:

She thought Social Security would be enough.
And because she thought Social Security would secure her retirement, Paige never saved a dime of her income.

At the very least, she should have contributed a small percentage of her income annually to an IRA, which she then should have invested in a domestic index fund like Vanguard 500 Index (VFINX), which invests in large-cap stocks like ExxonMobil (NYSE: XOM), General Electric (NYSE: GE), Procter & Gamble (NYSE: PG) and Apple (Nasdaq: AAPL).

For diversity, she could have added some small-cap holdings by investing in a fund like Royce Select I (RYSFX), which owns shares of Copart (Nasdaq: CPRT) and Plexus Corp. (Nasdaq: PLXS).

Investing in tax-free retirement accounts is the easiest (and first) step one should take toward planning for retirement.

She sold the stocks she inherited.
Upon her father's death, Paige cashed out all the investments she received. Had she held onto just one of the stocks in her father's portfolio, say Bank of America (NYSE: BAC), the annual dividends would be valued at around $40,000 -- less than the median household income in the U.S., but much more than the amount she receives in Social Security.

Had she held all the stocks she received for the long term, the annual dividend payments would today place Paige in the top 5% of American households for annual income.

She let inflation get the best of her.
Paige's money has not kept up with prices. The Senior Citizens League recently reported that expenses for retirees are up 88% since 2000. The increase in Social Security payments over the same period? Just 24%.

In other words, Paige's monthly check from Uncle Sam is buying her less and less over time -- and pretty soon, it could get her next to nothing. Brokamp advises retirees to keep a portion of their savings in safe bonds that adjust for inflation through a mutual fund like Vanguard Inflation-Protected Securities (VIPSX).

The Foolish bottom line
Living a comfortable retirement is not all that hard. But, as the example of my friend's mother shows, if you don't plan for retirement, you're in for some tough times.

This isn't intended to be an airing of grievances (after all, Festivus is months away). Rather, I hope that by sharing the mistakes she's made, I'll be able to help you avoid the situation she's trapped in today.

Copyright © 2008 Universal Press Syndicate.