10 ways to retire early — it’s not easy, but it’s doable
Reprinted courtesy of MarketWatch.com.
Most people look forward to retirement, and many wish they could retire earlier than age 65. I’m here to tell you that’s very possible, though it’s not necessarily easy.
A generation or two ago, retirement was relatively easy for many workers. You put in your time at one or two companies for a whole career, then you collected a secure pension at age 65, plus Social Security.
I know lots of people my age who retired that way and live well without having to dip into their investments to meet their daily needs.
- The new administration is proposing to rescind a new law that would require financial advisors to recommend products that are in our best interests.
- Interest rates are flirting with all-time lows, making it all but impossible to keep up with inflation, let alone make any money, from risk-free savings. From 1980 through 1999 short term U.S. Treasury Bills compounded at about 7%. From 2000 through 2016 that dropped to 1.6%. Currently, T-Bills pay only 0.5%.
- Long-term stock market returns, while always unpredictable, are widely expected to be lower in the future than they were in the past.
For these and other reasons, some advisors and pundits have adopted the phrase “80 is the new 65,” meaning many workers may have to work longer and retire later.
All that could be called “the bad news.” With that out of the way, let’s get to the good.
The good news is that many people have found ways to retire early. You can too. Here are 10 proven steps that will take you in that direction.
1) Save more money than you ever considered. Do your best to salt away 15% to 20% of your income. This will likely require you to live well under your present means, and you’ll sometimes miss out on things your friends and colleagues are doing.
But this will be terrific training for when you retire, because you won’t be accustomed to high living. I’ve met very few retirees who adjust easily to living on less, but I have met many couples who are content to spend the same in retirement as they did during their working years.
2) As you accumulate savings, do so in a methodical way by dollar-cost-averaging. This means investing a set amount regularly; the result is that you will automatically acquire more shares when prices are low and fewer shares when prices are high.
Over the years I have concluded that investors who use 100% mechanical portfolios in conjunction with dollar cost averaging are the most likely to consistently do better than the market.
3) Increase your savings as your income goes up over the years. Not yet saving 15% to 20% of your income? You don’t have to get there all at once. Set up an automatic savings plan that will raise your savings rate by two percentage points a year until you reach your goal.
Listen to Merriman’s podcast: “The three most important steps to early retirement.”
4) Make sure your spending and borrowing don’t sabotage your long-term plan. If you’re married, get your spouse on board with a long-term plan to spend less than you make now in order to have a better lifestyle later.
In virtually every case I know where young people are successfully saving over 10% a year, the spouse is 100% behind that commitment.
5) During the first 20 to 25 years of your working/investing life, keep your investments all in equities. You’ll read and hear lots of advice to keep some in bonds; when you’re young, don’t do it.
Bonds will sometimes bring you short-term comfort during times of market volatility. But they are not a good deal if early retirement is your goal: Their lower returns will deprive you of the long-term returns you need to build your investments.
You can expect that every 10% of your portfolio that’s in bonds will likely reduce your long-term return by 0.5 percentage points.
6) Keep your investments focused on the equity asset classes with the best rates of return over the last 50 to 90 years. Don’t yield to the temptation to invest in gold or other commodities.
A well-diversified stock portfolio is the most likely vehicle to take you where you want to go. If you want to reach for more growth, do it by tilting your portfolio toward value funds and away from growth funds.
7) Invest in those asset classes in ways that keep your expenses as low as possible, thus preserving your stock-market returns for you. Most likely that will mean investing in carefully chosen index funds or ETFs.
You can invest in an S&P 500 index SPX, +0.39% for less than 0.1% in annual expenses, about one-tenth of the cost of the average large-cap blend fund. This will put many more dollars in your pocket over a lifetime, and your family will likely be very impressed by what a good investor you are.
8) Avoid bailing out of the market for emotional reasons during market declines.
In the earlier years, when you’re invested heavily or exclusively in equities, take the time to learn enough about what you are doing — and why you’re doing it — that you can “stay the course.”
As you get closer to retirement, add some bond funds to reduce the volatility of your portfolio.
9) Be smart about the investment vehicles you use. The best options are the Roth IRA and the Roth 401(k). Maximize your opportunities to use those accounts, and you’ll be rewarded.
Under the current federal tax laws, any money you withdraw from such accounts will be tax-free. Trust me on this: When you retire you will appreciate that.
10) Don’t lose faith. It’s inevitable that your portfolio will suffer some setbacks during bear markets along the way. This is normal. These setbacks will hurt you only if you bail out in search of comfort.
Especially in your early investing years, try to adopt an attitude of welcoming the bear. Why? Because you’ll be buying shares at lower prices than you’ll find in bull markets.
Richard Buck contributed to this article.
Reprinted courtesy of MarketWatch.com.
For more than 20 years I have been recommending that investors of all ages put 20% of their equity portfolios into small-cap value funds and/or small-cap value ETFs.
Last year was a great one for small-cap value investors, and those who had taken my advice had ample reason to be glad they had done so.
The average small-cap value fund (including ETFs) gained 26% in 2016. (That’s more than twice the 11.8% return of the Standard & Poor’s 500 Index SPX, +0.06% ) Some small-cap value funds made considerably more, around 30%; and of course some made less.
Same management company. Same asset class. Significantly different results in this particular year.
I doubt very many investors in VISVX (the mutual fund) are crying in their soup about their sub-par performance. But still, when you are relying on a well-run company like Vanguard to get the returns of an asset class, you don’t expect to be trailing the averages.
All this leads to the question of the day: Why does one small-cap value index fund do appreciably better or worse than another? Later, I’ll get to the second question of the day: What, if anything, should you do about it?
I think the answer contains some good lessons on how investing works, particularly in this particular asset class.
There are seven variables that can be responsible for parts of such a difference. It’s worth your while to understand them.
1. The size effect. Small-cap value stocks, by definition, represent smaller-than-average companies. Small is better (by and large) than big. And smaller is better than not-quite-so-small.
If everything else is equal, a portfolio with smaller companies should perform better, at least in a year like 2016 when small companies outperformed larger ones in general.
This helps explain why VIOV outperformed VISVX; the ETF’s average portfolio holding was a company with $1.4 billion in assets — less than half the size of VISVX’s average company, $3.25 billion.
2. The value effect. Some companies have deeper value discounts (usually measured by the ratio of a stock price to the company’s book value) than others. In a year like 2016 when value companies outshine growth stocks, deeper value (indicated by a lower ratio) should be an advantage.
And that proved to be the case. VIOV’s higher performance came with an average price-to-book ratio of 1.65, showing slightly more value orientation than the 1.75 of VISVX.
3. Expenses. When other things are equal, a fund with lower expenses will always have a greater return than one with higher expenses.
Both VIOV and VISVX have operating expense ratios of 0.2%, a suitably low figure. So in this case, they are equal — and considerably better than average: The average small-cap value ETF expense ratio is 0.37%; for mutual funds, the figure is 1.31%.
4. Portfolio turnover. Beyond the operating expense ratio, fund investors also pay more when a fund buys and sells its companies more rapidly. Higher turnover, in other words, adds additional expenses.
This helps make the case for funds and ETFs that follow indexes. Actively managed small-cap value funds average turnover that’s two to four times as high.
In this instance, VISVX had an advantage last year, with turnover of only 16%, compared with 42% for VIOV. The average small cap value fund and ETF had an average turnover of 78%.
Those four factors make the most difference when comparing one fund against another.
But three others can matter quite a bit as well.
VISVX holds 830 companies, much more than the 436 in VIOV’s portfolio. I am not sure how this might explain the difference in 2016 performance, but it’s an important point of comparison in any two portfolios. Because the companies in the VIOV portfolio were so much smaller, then the mutual fund’s broader diversification could have hurt rather than help VISVX’s performance.
6. Sector exposure. You could also categorize this one as luck, because various industries go in and out of favor from time to time.
The portfolios of VIOV and VISVX have major differences in the way they weight various sectors. For example, in 2016 VIOV’s portfolio was overweighted in consumer cyclical stocks and underweighted in REITs, compared to VISVX.
Such differences may even out over the long term, but in any particular year they can have a meaningful effect.
7. Individual investors’ timing. This isn’t really a trait of a fund. It’s a trait of an investor.
If you bought a fund on the last trading day of 2015, made no changes through the year and sold it on the last trading day of 2016, your return should be the same as that of the fund. But this doesn’t always happen.
If you waited until February or March to buy, or if you sold in October instead of holding until the end of the year, you missed a significant part of the fund’s return.
Individual timing is usually detrimental to returns, because investors tend to buy when others are buying (hence prices are rising) and sell when others are selling (when prices are falling).
Although this factor is about you, not any fund you might own, it’s an important thing to keep in mind when you’re comparing your performance to that of a fund, or to market averages.
Now, the second question of the day: What should you do about all this?
1. When you’re comparing small-cap value funds, focus on the four long-term variables: size of companies, value orientation, expenses and portfolio turnover.
2. If you’re deciding between VISVX and VIOV, the latter (the ETF) may be a better long-term choice.
3. If you own VISVX in a taxable account, don’t sell it in order to switch to the ETF without carefully considering the tax implications.
This comparison between the ETF and the mutual fund has led me to believe that in some cases, Vanguard investors (as well as those at other companies such as Fidelity and Schwab) may be best served by portfolios that include a mix of mutual funds and ETFs, not just one or the other.
I intend to study this issue in 2017, and I may come up with a new set of recommendations.
In the meantime, if you’re following my current recommendations there is no need to make a change.
Although it’s unrelated to this topic, I hope you will check out my latest podcast, “How to Invest During a Trump Presidency.”
Richard Buck contributed to this article. Paul Merriman and Richard Buck do not own the investments mentioned in this column.