By Andrea Coombes, MarketWatch
Step 2: How do I invest?
Just as reining in spending is a recurring theme among early retirees, so is the idea of investing in a diversified portfolio of low-cost index mutual funds. Generally, mutual funds that track an index, such as the S&P 500 index /zigman2/quotes/210599714/realtime SPX +2.47% , will charge investors lower fees than mutual funds where the portfolio of investments is chosen and “actively” managed by a fund manager.
For a straightforward guide to low-cost investing, look no further than MarketWatch’s Lazy Portfolios. Each of the eight Lazy Portfolios holds 11 mutual funds or fewer; a couple of the portfolios hold just three mutual funds.
Among these portfolios, the current top three performers — the Coffeehouse portfolio, Dr. Bernstein’s No Brainer portfolio, and Second Grader’s Starter portfolio — have returned 8%, 9% and 10%, respectively, on average over the past three years (data are through Dec. 8, 2015).
The current top performer, the Second Grader’s Starter portfolio, comprises just three mutual funds: 60% of the portfolio is in the Vanguard Total Stock Market Index Fund /zigman2/quotes/202876707/realtime VTSMX +2.55% , 30% of the portfolio is in the Vanguard Total International Stock Index Fund /zigman2/quotes/210096929/realtime VGTSX +1.23% and 10% of the portfolio is in the Vanguard Total Bond Market Index Fund /zigman2/quotes/206402661/realtime VBMFX +0.10% .
Worried about investing for retirement? All you need to do is try to match one of these portfolios. That doesn’t mean you need to invest in precisely the same mutual funds; the point here is to pick a portfolio and then mimic it by investing in similar mutual funds, e.g. an index fund that invests in a broad group of international stocks.
If you’re investing through a 401(k) or other workplace account, your investment options will differ, but you can try to get as close as possible to these suggested portfolios. You don’t have to stick with Vanguard mutual funds (though that company is known for its low-cost funds).
Once you’ve picked a portfolio and done your best to match it given the investment choices available to you, then allocate your money as per the portfolio (e.g. 60% to a total stock market index fund) and stick with it. You don’t need to know any more than that to invest. That said, you should monitor your own investment portfolio regularly to make sure your percentage allocations don’t get out of whack. When, for example, the U.S. stock market gains steeply, you may need to rebalance, i.e. push some of your investment money toward bonds or international stocks, say, to get your portfolio allocations back to the percentages stated in your chosen Lazy Portfolio.
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Step 3: Housing costs in retirement
A key piece of retiring early is keeping your housing costs low. If you plan to live in the U.S., the ideal situation is to pay off your mortgage before retiring, as the Money Mustache family has done. But as noted in No. 1 above, the key to retiring early is a simple function of how much you spend versus how much you have in income. If you save enough such that you can cover your mortgage costs after retiring, then there’s no inherent problem with holding on to a mortgage.
Many retirees cite the significant psychological value of carrying no debt when they quit working, but with interest rates as low as they are, others argue that holding the mortgage and investing in the financial markets the cash that otherwise would pay off the mortgage can be a smart financial move.
For some retirees, however, the proceeds from selling their home may in fact fund a good chunk of their retirement, whether they end up using some of the money to buy a smaller house in the U.S. or on cheaper accommodations in foreign lands. For example, the Yetters chose the latter path. Now, thanks to housesitting websites such as TrustedHousesitters.com and MindMyHouse.com , they say they live rent-free about 70% of the year, in places such as England, Italy and Greece.
The danger of relying on home equity to fund retirement is that it assumes the local housing market is strong when it comes time to sell the house and retire; it’s crucial to take this uncertainty into account and build a flexible timeline into one’s retirement plan.
For their part, the Kaderlis travel the world, yet they own a home in an active adult community in Arizona. They lease the land and pay “lifestyle fees” for the various amenities, such as a swimming pool and cultural activities, which they enjoy when they’re in the U.S. Most of the time, however, they’re traveling the world, staying in hostels and hotels, renting apartments and housesitting. They enjoy discounts by booking longer-than-average stays and going to places in the off season. They live on about $30,000 a year, including health-care costs, airfares, housing and living expenses.
Step 4: Paying for health care
Early retirees deal with the issue of health insurance in a variety of ways. Individual costs will vary widely, depending on the situation. Certainly, the availability of health insurance in the U.S., thanks to the Affordable Care Act, has made it easier for individuals to quit jobs they might otherwise have kept for the health insurance.
Mr. Money Mustache, the popular blogger and early retiree based in Colorado, said last year that he relies on a low-cost, high-deductible health plan purchased on the individual market. The plan costs about $275 a month to cover his wife, son and himself. Should that plan expire, he said he would switch to a bronze plan, available via his state’s health exchange under Obamacare.
Meanwhile, the Yetters spend most of their time traveling internationally. They purchase health insurance for about $120 a month from a company called World Nomads. When they visit the U.S., they buy temporary catastrophic coverage.
Like the Yetters, the Kaderlis spend a good chunk of every year living in other parts of the world. When they travel to the U.S. they purchase a temporary traveler’s insurance policy for U.S.-based care. When they’re elsewhere, they pay out of pocket.
Step 5: Manage your taxes
Just as when we’re working, taxes are a consideration in retirement, whether you retire early or not. It’s crucial to include an estimate of your annual tax bill in your “total savings needed” amount.
Your tax bill may come in a variety of flavors. If you’re pulling your income out of a taxable brokerage account, you’ll most likely owe capital gains on those distributions.
If you’ll be withdrawing money from retirement accounts such as IRAs and 401(k)s, you’ll owe income tax. If you’re younger than 59-1/2, you’ll also face a 10% penalty, but there are ways to avoid it. Be sure to familiarize yourself with the “72-T” rule. This rule outlines a precise process for distributing retirement funds such that you avoid the 10% penalty on early withdrawals.
Also, your Social Security benefits are taxable if your income exceeds a specific amount.
Keep in mind that, if you continue to do consulting or part-time work after your official retirement, then any Social Security benefits you’ve claimed will be temporarily reduced.
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