Investing for Early Retirement
One of the most challenging parts of contemplating early retirement is deciding a good investment strategy. By comparison, a savings strategy is straightforward. Most people who are contemplating early retirement have a plan to save a certain amount of money per paycheck period and methods to help with that savings plan (such as automated withdrawals). However, with investment, there are many many options: stocks, bonds, annuities, options, international investments, commodities, etc…. and frankly a dearth of good recommendations of what to do. The challenge with early retirement is that someone who retires early needs to anticipate three things: income stream, future inflation and expense increases, and a long period in retirement.
Current investing for retirement planning seems to address the type of retiree that retires at age 65 and anticipates around 15-20 years of needing a stream of income. In addition, many current retirees have more traditional pensions and in the United States, retirees have been able to collect 100% of the stated social security benefits thus far. What a person who retires early needs to consider is that if they retire at say age 40, they may have 40-50 years in which they will need to make their investment portfolio last, and that is without any significant shift in lifespans. In addition, fewer and fewer people have pension income that they can count on, and early retirees will usually not qualify for retiree benefits (such as social security) for many years to come.
One of the biggest risks to retirement portfolios was seen with this recent bear market: where early withdrawals, coupled with declines, causes the principal value of investments to be hit sharply. For retirees that had set aside a stash of liquid holdings (such as bank CDs) that could be redeemed at this time, holding off on selling down depleted assets is a good method of preservation.
Putting all of the above together, I have the following broad ways in which I look at my investment portfolio, with the intention that I will be utilizing dividends for substantial income flow and trying to protect against anticipated inflation and safeguard against a sharp bear market:
–Have a large portion of the portfolio in assets that have substantial dividend ability including high yield stocks, and some bonds, much in non-US markets. This is held through index funds and ETFs. (This is about 60% of the portfolio)
–Aim the portfolio to grow overall at a rate above the withdrawal rate. Since I think that faster growing countries outside of the US will achieve this, I have a significant allocation of investments in emerging markets and non-US dollar investments (This is about 30% of the portfolio)
–Set aside a liquid cash pile that can be withdrawn in case of emergencies, a sharp decline in dividends, or a sharp drop in the equities market. (This is about 10% of the portfolio).
I’m interested in hearing from others how they are approaching building a portfolio for early retirement.
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I’m still working on my allocation plan. There will be mostly stocks and some bonds and some REITs. There will be lots of rebalancing. I will start off with about 10% in cash-like things (more if the market is looking bubbly, less if plummety). I will withdraw some amount (probably 4-7%, ideally growth – inflation) each year. The amount I withdraw will not be adjusted for inflation each year, but will be just the usual percentage of whatever my current total is.
This means my income will go up and down drastically from year to year but I should never run out of money. I’d rather have a few rough years here and there throughout my retirement than a lot of years at the end with no money at all.
To smooth out the roughness a bit, during those years when I withdraw more than I need, I’ll put the extra into cash, and when less than I need I can take some extra from cash. Also I will be debt free and own my house. And if I last 6 more years without the rules changing, I’ll have a pension.
I like to think of Social Security as inflation protection–there will still probably be something there by the time I qualify, but who knows how small it will be. So I will assume there will be nothing, and then when inflation or expenses go up more than I expect, maybe that will cover me.
Debbie, This is an interesting approach. I also have some investment in REITS (both US and foreign) through ETFs. With your plan, the main thing I would be concerned about is that in a year when the portfolio goes sharply down, to make sure you have enough put away in the extra cash side to tide you over.
My personal expectation is that actual inflation goes up quite a bit, and social security goes up by less, effectively devaluing it; but we’ll have to see.
Thanks so much for commenting.
[...] Modern Gal Investing for Early Retirement A variety of considerations to think about San [...]
Ideally, I’ll have expenses so low (with my house paid off) that I can stand a low income sometimes. And I do have savings accounts for things like home repair, car repair, and next car so that I should be able to afford those kinds of emergencies even when the timing’s bad.
I’m going mostly with index funds all with the same rather than ETFs so I can rebalance for free.
My biggest fear is huge medical expenses. Even people who stay in shape and find recipes that make vegetables yummy break down as they age.
Hi Debbie, you sound well prepared. My biggest fear is also medical expenses. I am researching medical tourism and have several friends that have received treatment overseas and are pleased with the results.
Thanks so much for sharing.