Monday, January 20, 2020

How to Prepare for Early Retirement

Preparing For Early Retirement: The Dividend Growth Investment Method


Summary
Early retirement is not for everyone, especially for those driven by workplace goals and ambitions.
We personally know multiple people who have retired early.
Retiring early takes planning and foresight.
Saving too little and spending too much can cause an early retiree to have to "un-retire."
Looking for a portfolio of ideas like this one? Check out my dividend growth dividend portfolio with M1 Finance. Get started today.
Today I want to touch on questions posed to me frequently when I am with friends and family:
"How do I retire early?"
or
"What steps should I take to prepare for early retirement?"

Early Retirement - The Ultimate Goal?

Early retirement is often a lofty goal people claim to have. However few actually achieve it or take appropriate steps to reach this goal. How early do you have to be for it to be considered "early retirement?" Often early retirement does not consider individuals that sneak out of the workplace a few years before their peers, but more so those that retire 10-20 years earlier.
The "FIRE" movement, which stands for Financially Independent, Retire Early, has recently become popular. Stories of people reaching these goals are easy to find thanks to the Internet. Whether real or made up, they drive the imagination of workers all over the world. They provide ample daydreaming fodder for those trapped within the repetitiveness of a job they may or may not hate or just about tolerate.
While we cannot decide if retiring early is for you, applying the dividend growth income Method to your investing and saving makes it more achievable. Let us look at some considerations, steps and ideas surrounding early retirement through the lens of immediate income investing.

Determine Your Retirement Lifestyle

The first step is to ask the right questions. What are your annual budgetary requirements on retiring? Will you live simply or have an extravagant lifestyle? Will you reside in a retirement-friendly state with a lower cost of living and fewer taxes or not?

Moving from a high-cost area, like New York or California, and retiring to a low-cost one, for instance in the Southeastern United States, is one way many would-be retirees find to stretch their savings and investment income.
Choosing to remain in a high-cost state will extend the overall time required to save or invest to reach your goals.
One reason many early retirees end up back in the workforce is from underestimating their expenses or changing their mind about major life decisions. What if you decide to have children or more children? Those big changes can drive you right back into the workforce.
What's the best way to find your "number?" Ideally, your magic number will include "how much" you need to live while adding in additional room for reinvestment. To help determine your cash flow requirement, a retirement mock budget should be created.

Make as Realistic of a Retirement Budget as Possible

Retirement will have its share of expenses. Your power bill, phone bill, and health or car insurance do not just stop because you stop working. You will need to factor in those bills, along with an allocation for hobbies or vacations you want to take with your new-found free time.
Working 40 hours a week leaves most people with little time for excess spending on hobbies or experiences. Having that time suddenly available means that if you are not careful, you could start seeing your spending increase significantly.
Being as detailed as possible by budgeting for gift giving or replacing clothing, for example, will make it relatively more accurate. We would suggest erring on the higher side versus being too stingy. Once you have found your number, you need to move onto the next step.

Save Money, Lots of It.

You have got your number down. It's time to start building that nest egg. Unlike retiring at a "normal" time, retiring early means some of the more conventional tools cannot be used. IRAs with penalties for early withdrawals are not ideal solutions. This means you will need most of your cash flow to come from an accessible source - like a taxable brokerage account. This has tax consequences as your capital gains are realized and as dividends roll in. It also means K-1 securities, while they complicate the tax filings, are a friend for deferring taxation of distributions.
Let us say you are considering having a budget of $50,000 of annual retirement income. The standard "4%" rule cannot be used since you have "preponed" your retirement period. We also are not a fan of cannibalizing our capital needlessly. So how much of a nest egg do you need to have to achieve $50,000 of annual dividend income?

Currently, the S&P 500 (SPY) yields about 1.75%, 7-10 year US bonds (IEF) yields 2.08% and Vanguard real Estate ETF (VNQ) yields 3.39%. We stack these up against our M1 Finance Portfolio which uses our dividend growth Method and yields 9%-10%. For this example, we use a yield of 9%.

To generate $50,000 annually, your investment choices vastly change the amount needed.

Very few people have more than $2.5 million sitting around waiting to be invested or built up with their investments to retire 10-20 years early! You see, dividend income investing is by design, focused on making your portfolio work for you now, in the present, by providing strong dividend income. It lets you forgo worrying about price movements when your dividend remains unchanged.
Using high-yield high-quality choices like PIMCO Dynamic Credit Income Fund (PCI) and PIMCO Corporate & Income Opportunity Fund (PTY), both of which yield 8.2% and pay monthly distributions, you can see strong income generation.
Also, by choosing your investments and not simply DRIPing or hopping on a preset list of securities, you can take control of your portfolio's yield and reinvest to maintain or boost it over time. I found my portfolio picks by looking past the noise of market sentiment and digging into the fundamentals of a company. Last year especially we saw that sentiment has driven investing more than facts. If you are dependent on price changes to survive retirement, this would be a worrying trend. On the other hand, if you are investing for dividends, this trend actually helps create more opportunities by enabling you to find high-yield value picks!
How can you save the money needed to retire early?

Cut Debt, Trim Expenses, Live Simply.

Debt and expenses are half of the equation and the only guaranteed returns in any market. By paying off debt, especially high-cost debt, you reduce your expenses.
The stories of most early retirees are stories of Spartan living. Almost never do they live luxurious lives while working, but scrimp and save every penny to make their dream a reality. This is where most fail: They want early retirement, but don't want to make the sacrifices to achieve it.
By eating at home, instead of eating out, most people can save extra money and use this to build their nest egg or pay down debt.
One major expense that's often missed by those seeking early retirement is health insurance. For US-based investors, Medicare does not become available until you are 65 years of age. This means if you're retiring years in advance, you will need to find coverage and pay for it out of pocket. For would-be retirees currently working and enjoying an employer's health insurance plan, this expense is often missed in their budgeting and has a surprisingly high cost.

Conclusion

Retiring early is a lofty goal. Using our dividend growth investment method we can make it more achievable. Investing in a high-yield portfolio that generates recurrent large cash inflows has many advantages. One such advantage is that it allows you, through the dividends received, to have more control of your investment decisions. You can choose how to deploy the cash, directing it between personal expenses, and reinvesting it in your current portfolio to boost your future income. You also can decide to use it to invest in new opportunities or holding it in cash. A portfolio with 9%-plus cash yield is extremely flexible and can be adjusted to changing financial conditions, if you are close to retiring or already retired. Working with M1 Finance broker you get the chance to do that by investing as low as $10 with fractional shares that pays you dividends  with no broker or commission fees or even trading fees and over time the compounding effect will snowball your portfolio to buy more shares so that you get  more dividends which in the future will be used to pay you a monthly income. 
Regardless of what method you use, multiple sacrifices now would be necessary to retire 10-20 years ahead of the norm. As always we hope you have a prosperous and successful investment journey!