24 and looking ahead

[MyOwnTime]

Umm. Hi.

So here's the thing: I'd always subconsciously assumed I'd retire in my 40s, because to me it seemed the "normal" thing to do. My father dropped to part-time work at 45 and quit completely at 49; my mother was stay-at-home until I left home, and now works part time at a job that pays beans because she really likes the people.

It's only in the last year or so that I've really started consciously confronting the fact that 1) I want to do the same thing, 2) most people would consider that "early" retirement, 3) many people would not -want- that "early" retirement, especially if it needed to come combined with a LBYM approach, and 4) if I'm going to do that, I probably need to pay more attention to my finances beyond "LBMM and let my portfolio sit and accumulate," which is what I've been doing.

I am very fortunate in that I inherited a large sum from my grandmother in my early teens. Some of it was designated to pay for my college expenses; the rest has been sitting around in investments and is currently worth around $1.1 million. Right now it's about 25% in Vanguard's S&P 500 fund, 10% in money market, and 65% in a piece of rental real estate. The real estate will be sold in the next few years; I'd like to learn more about portfolio management now to get a sense of what to do with that portion of the portfolio once it's liquid and no longer held in trust. (Bonds? A higher growth mutual fund? Something in the international market? Real estate for myself to live in?) I'm open to thoughts on reallocating the other 35% (most of which is not held in trust) now, but my inexpert sense is that now is a crappy time to be selling S&P 500 shares and I might as well let it sit as-is a little longer.

On the "not just living off the labors of my ancestors" side, I currently get paid in the 40s and save about 20%, after tax. I have no tax-advantaged savings vehicles. Obviously, that isn't good; I'm trying to work out what my best options are and how I should go about setting them up. (My job does not offer a 401k, or any variant thereof.) I’m thinking I should start a Roth IRA now, and then switch to a regular IRA once the portion of my inheritance still held in trust devolves to me, and my tax bracket goes up accordingly—does that make sense?

I'd like to be able to stop working full time around 40, perhaps spending the first few years in "partial" retirement, with an annual income of around 60k before tax in today's dollars. Obviously, children are a big variable; both I and the bf (who is significantly older than I am, but not interested in early retirement) are certain we don't want them, which simplifies things. The numbers above are all for just me--if we ever decide to combine finances as a couple. . .well, we'll deal with that when we get there.

From playing with FIRECalc my goals seem achievable, though I know predicting for a 50 or 60 year retirement has a large component of guesswork. Feel free to tell me I'm crazy, of course! And I'd welcome any advice for simple investment reading, or for what good pre-tax savings vehicles would be.

[Coach]

MyOwnTime, welcome to the forum!

It sounds like you've pretty much got it made and should be able to do pretty much whatever your want. That's an enviable position to be in.

I'm glad to hear that you're planning to take your time, learning about investing. There's no big rush to do anything, and I suspect more investment errors are made in haste than in leisure. How old are you now?

Others will be along with investment reading recommendations, but I'd like to suggest you read The Millionaire Next Door. After all, you are one

Best of luck!

Coach

[jIMOh]

Welcome. Dividend investing is a good way to fund early retirement. I would look to put a portion of real estate sales into a dividend heavy or large cap value fund.

Dividends:
1) tend to increase over time (increase faster than inflation too).
2) prevent you from selling shares to raise income
3) move the SWR into 3% or 2% range, which is sustainable for long periods (50-60 years).

[xynny]

Wow! I'm so glad to see more people my age on these forums. I think you're in a great position. If you work another 16 years your portfolio will grow to a pretty good amount for you to retire without worrying too much I think. You're more sane than people I know who spend more than what they earn!

[kevin92610]

Impressive early start!! I would have loved to be in your position at 24.

ONE COMMENT: you seem concerned that you are not in any tax advantaged savings (401K, Roth IRA, etc.,). I retired at 40 and all the money that I did tie up in a 401K is still sitting there because I can't get it without penalty until my 60's. Personally, I wouldn't be that interested in that type of investment if I had your net worth when I was your age. It will just be money that you don't have access to when you are ready to retire. Another reason is that since you are most likely going to be a high net worth individual when you hit your 60's the general assumption that is made with tax deferred investment vehicles (that you will be in a lower tax bracket when you withdraw the money) isn't going to apply to you.

regards, Kevin

[Darryl]

Well, you are in a good position and have outlined very achievable goals. I agree with Coach "more errors are made in haste than in leisure" I would also second his reading recommendation of millionaire next door and add four pillars of investing and bogleheads guide to investing.
Use the time before the rental real estate is sold to educate yourself about investing. As far as the S&P fund goes I currently have 25% of my portfolio in an S&P 500 fund and believe it to be a good second choice to a total market fund. Be careful about thinking you know when a good time is to buy or sell if you are in the market for the long haul the odds are on your side. If you start hopping around the odds are not so good. Yes max out that Roth now while you can.

[MooreBonds]

Quote:

Originally Posted by MyOwnTime Umm. Hi. 65% in a piece of rental real estate. The real estate will be sold in the next few years; I'd like to learn more about portfolio management now to get a sense of what to do with that portion of the portfolio once it's liquid and no longer held in trust.

Welcome to the forum MOT!

One bit of advice - I realize that you're just now dipping your toes into the water with investments in general, and that you may not know too many of the real estate ins and outs....but don't be so hasty as to assume you should ditch the real estate!

Granted, you hinted that it may be in a legal entity (trust, etc.), and that can have a big bearing on your options, but real estate is far and away a significant way for the 'average Jane' to accumulate a huge estate. The reason is that if you sell your real estate (pending the particulars of the entity that currently owns it), there will likely be a large depreciation recapture tax owed, in addition to capital gains taxes. That could very well leave the ~$650,000 real estate value at more like $400,000 - or possibly much more or much less, depending on how much accumulated depreciation there is, etc.

However, if you (and any other beneficiaries in the trust) are able to do a 1031 exchange, you can roll over the proceeds from the real estate sale into another property, and not pay capital gains or recapture taxes on it. So, in effect, your $650,000 is still invested for you, and you're earning income off of it (and hopefully writing off depreciation against your income, thus lowering your taxes!). If you keep doing that, you could wind up with a several million dollar property portfolio in your 40s/50s, which would yield a fairly decent income stream.

While real estate isn't a sure thing, it wouldn't hurt to do some more digging to find the particulars of what you'd be looking at if you liquidated the real estate holdings in a few years, and what 1031 options you have available.

Apart from that, I'd second the comment about doing a ROTH IRA - as well as a Health Savings Account (HSA), which is a no-brainer if you have good health and want to stash away $3,000/year, deduct it against your taxes, and then let it function as a tax-deductible retirement account.

[MyOwnTime]

Thanks for the warm welcome, all!

Coach, I'm 24. Still a ways to go till retirement. I'll check out the book next time I'm at the library--though I gather it talks more about earned wealth than inherited wealth?

jIMOh, would the S&P 500 not be considered dividend-heavy? With a sixteen year horizon, I think I'd like to keep a decent portion of my investments growth-focused rather than income-focused for the time being. Also, I'm not sure I understand your advice regarding SWR: in what way would hypothetically spending 4% of your portfolio, of which 2% is capital gains and 2% is dividends be different from withdrawing 4%, all of which is capital gains? Are there positive tax implications to having more of your income come out of dividends rather than capital gains? At the moment, my dividends are automatically reinvested, so I don't really think of the money any differently than I do the capital gains, except when April 15 comes around.
xynny, your blog looks interesting. I'll try and remember to stop by.

kevinlongrandomnumber, I'm not really comfortable calling my financial situation "impressive," since I haven't done anything to cause it except not screw up and spend it all. (Though the more I read financial advice sites, the more I realize I may be undervaluing that. I have no idea how I'd begin to spend so much money, but apparently many people manage it.) And yeah, I'm definitely pondering tax brackets. Roth seems the way to go.

. . .which Darryl confirmed. Thank you for the extra book recommendations; looks like I'd better bring a bag when I go to the library.

MooreBonds, the decision about the real estate is a tricky one. There are a lot of reasons to sell the current property, but I have considered whether it's worth reinvesting it in a different rental. At this point in my life, though, I don't think I have the skills or inclination to manage rental property. I'd rather have a passive investment, even though it means losing money on taxes. But there's still lots of conversations with the accountant to go before a final decision is made, and that could yet bring me over to your point of view. Just have to keep reminding myself there's no rush--it's not like the house is going anywhere. (Probably. It is in an earthquake zone. . . .)

[Texas Proud]

You got a great start from you grandmother.... thank your lucky stars for that...

I would agree that a ROTH is the best for you right now.. your taxes are in the low range and will be going up.... max this out ASAP...

But, with the amount you have and how much you are putting away.... normal growth will be plenty....

One of the things you might look at is keeping the money in a trust... that way if you get married and IF you get divorced, these are separate assets and you get to keep them...

Good luck in your life!!

[MooreBonds]

Quote:

Originally Posted by MyOwnTime Also, I'm not sure I understand your advice regarding SWR: in what way would hypothetically spending 4% of your portfolio, of which 2% is capital gains and 2% is dividends be different from withdrawing 4%, all of which is capital gains?

I'm not attempting to speak for jIMOh....but one thing to keep in mind: if your withdrawal strategy depends on 4% capital gains/year - remember that the market doesn't always go up. ....by relying on a mix of dividends and capital gains, you greatly reduce your dependence upon selling assets to live off of - and probably extend your portfolio's survivability during a(n extended) bear market.

[jIMOh]

Quote:

Originally Posted by MyOwnTime jIMOh, would the S&P 500 not be considered dividend-heavy? With a sixteen year horizon, I think I'd like to keep a decent portion of my investments growth-focused rather than income-focused for the time being. Also, I'm not sure I understand your advice regarding SWR: in what way would hypothetically spending 4% of your portfolio, of which 2% is capital gains and 2% is dividends be different from withdrawing 4%, all of which is capital gains? Are there positive tax implications to having more of your income come out of dividends rather than capital gains? At the moment, my dividends are automatically reinvested, so I don't really think of the money any differently than I do the capital gains, except when April 15 comes around.

Dividends are income which would do one of two things:

1) buy more shares
2) get spent by you (without selling any additional shares).

The key is that living off dividends means you did not sell your original shares. Plus the payout of the S&P 500 has surpassed inflation. Bonds, capital gains and similar generally do not keep pace with inflation.

Generally, dividend investing will overweight positions which pay a dividend. My guess is half the S&P 500 does not pay a dividend, and most index funds which track the S&P 500 pay out around 2%. If you look hard, you can find large cap value funds which yield 3-5%. I know of one fund which yields between 8-10%. These are funds which are 100% equities- which suggest growth is the goal, and the payout/yield is good enough to live on while the value of the shares in question increases (over the long haul).

Short term- the dividends cover expenses every quarter or every year
Mid term- the yield of the fund stays moderately consistent and the payout covers all expenses
Long term- the value of the shares appreciate (based on the value of the stocks increasing), so the yield is now higher, keeping up with or surpassing inflation.

If you plan for a 3% SWR, my thought is you can get 3% with 100% stocks or 80/20, assuming the stocks held have a dividend focus (either through mutual funds, ETFs or individual stocks).

I was not suggesting holding anything higher than 20% bonds when doing dividend investing.

Tax implications- current federal brackets are 10%-15%-25%-28%-33%-35%. If money is in an IRA, you will be taxed at one of these marginal rates. Taxes on dividends will be 5% or 15% (based on current tax law). If earned income is in 10 or 15% bracket, your tax on dividends will be 5%. If your current marginal bracket is 25% or higher, dividends are taxed at 15%.

In both cases the taxes on dividends are LESS than you would pay on IRA withdraws or earned income.

I am 18-38 years from retirement. I have 45% of my portfolio in a dividend centric mutual fund (PRFDX). The goal (for me) is to get the payout of this fund to cover close to 50% of my expected retirement expenses.