In Part One of Retirement Savings we discussed the three kinds of savings, and the planning you might use to catch F.I.R.E. The three kinds of savings to consider are: After-tax (AT) Savings, Pre-Tax Savings (PT), and (ST) some tax savings that is in-between AT and PT savings.
- In the first category, after tax(AT), you have: bank savings accounts, personal brokerage accounts, and everything that you save from money you have already paid tax on: like the deposit into a ROTH IRA.
- In the second category pre-tax (PT), you have: 401-k, 403-b, SIMPLE IRA, SEP and personal pre-tax savings, the IRA.
- In the third category, some tax savings (ST), you have an annuity (that you did not put in an IRA or Qualified Employer Plan) and some parts of the Roth IRA. The money going in to this type of account is after-tax money. The gains coming out will be taxed as ordinary income and penalized before age 59 1/2.
My favorite method of saving for retirement, particularly if you want to catch F.I.R.E., is to pay your taxes now, use a personal brokerage account and a Roth IRA.
START YOUR “Early Retirement” Savings Plan
Your after-tax brokerage account(s), or AT savings is where you start to catch F.I.R.E. For these purposes, I prefer individual stocks to mutual funds. You have more control. (Your broker will help you.) You have tax control unavailable in mutual funds and while drops in the stock market can be an advantage to regular buyers like yourself, in a mutual fund they can spell tax disaster if the fund must sell to keep up with those withdrawing out of fear.
Buy a few shares of a stock (utility, energy company, blue-chip, dividend paying) you are familiar with. You might start with your utility company, or Cocoa Cola, or AT & T. I would suggest a well know company with at least a 4% to 5% dividend. You reinvest the dividends and each month you add a little bit more money – shares – to your portfolio. Ideally, you want a stock that is well below its high, that will pay you a good dividend. Your broker can be instrumental in setting this up and explaining which stocks you might consider. Keep your costs of doing this less than 1-2%.
After some time add a second stock, after more time a third, then a fourth. One of the best portfolio’s I have ever seen was made up of utility stocks and municipal bonds, held for 20 plus years that just reinvested the dividends.
Let’s say you are nervous about the market. You need to save, but 2008 still rings in your head. That’s ok! First look at where the market is today verses where we were after the drop. The market has been good to all of us lately.
But if you are nervous, consider a sell stop (SS). You have some control over how much you would lose in the event of a large drop. To me a large drop would be a buying opportunity. But if you are close to “early retirement” protecting those investments is crucial. You really don’t want a market drop to change your carefully laid plans. A SS does not set an exact price of sale. What it does is put your sell order on the sell list the minute a certain price level is hit. For now, consider keeping the SS 15% to 20% below the current stock price, as you don’t want the SS to trigger a sale with ordinary market movement. Remember, if you are close to (within 5 years of) your F.I.R.E. date, make the SS closer to the stock price. Again, your broker is there to help and advise. You are there to make decisions. It is, after-all your money.
That AT account is the basis for the money you would use to retire before age 59 ½. This account is part of a plan you need in preparation for that wonderful day. The day you “retire.” This plan goes along with your “budget,” and “managing your debts and credit report.” When you catch F.I.R.E. and retire before all your friends, all you will do is stop reinvesting the dividends and take them as cash. If the stocks are in US based companies and tax law is still the same, you may even get a tax break on the dividends you are starting to spend! One of the nicest things about planning for this event is that you can project how much you will need invested to get the income that you need to live on before taking your Social Security.
For example: $400,000 invested over 35 years (with a 5% dividend coupled with a 2.5% growth rate), is an investment of about $222 a month. Stop the investment, turn on the dividends and you have an income of $20,000 a year for the rest of your life from this account alone. Put another way it cost you $93,240 over 35 years and you could withdraw $20,000 a year. Your investment pays you back in less than five years. This type of investing takes time and patience. But it works, and it works well.
Early Retirement
I think it important to talk about your goal: “Financial Independence – Retire Early.” Keep in mind that your goal of early retirement is not a sprint or a marathon, it is a journey.
I am retired. I planned it, and I love it. The whole reason for getting to retirement early is what you will have, what you dream of and what your life can be! If your life, (work, family, bills, and little time for yourself) is anything like mine was, there is a considerable amount of stress as the demands on your time are large, and seemingly never ending. Kids, boss, job, house, marriage and the day to day “stuff” of life may not give you much time for yourself or if you are married, your mate.
Retirement changes all of that! If you have done a good job with the kids, they are no longer dependent on you. If you have retired, the job is gone the boss is gone and much of the demand on your time…is gone.
What are things you dream of doing, but just don’t have time? What are the things you will “get to someday”? What is that hobby you don’t have the time or the money for? Where do you want to travel, but can’t see how? Retiring” is not having nothing to do. It is having the time to do what you want to do, and most importantly to create the life you want to live.
If you plan it, it will come! We live in Italy. (It is less expensive to live in much of Europe than in the US.) I write, I photograph, I travel. We do so on a limited budget. You can live your dream too. You can have the time, the money, and the energy to explore your world! A world that today you only dream of……. Catch F.I.R.E and it’s all there for you!
