Income for Early Retirement, Another Take...

[panhead]

So, I was just daydreaming a bit and noticed something. This is an approach similar to what Scrabbler says he does, so probably not much new, just would like the boards take on it.

Let's assume a portfolio of about $1,250,000. Assume $400,000 in a 401k and the rest in taxable. Expenses in retirement are about $43K.

Portfolio: $1,250,000 ($400k in 401k, $850K in taxable)
mortgage on current residence: $100k 28 years remaining @ 3%
Rental house mortgage free generating $5,000 a year in profit including maintenance and vacancies
another rental house with a 15 year mortgage covering all it's own expenses
Expenses are $43K in retirement with about $3K discretionary
Assume another non-income producing property worth about $100k if sold.
Assume 45 Years Old

Take $800k from taxable in put in high yield vanguard bond fund @ 5% SEC yield ($40K)
This added to the $5k from rent is $45K or enough to cover expenses and then some
For simplicities sake, put everything in the 401k in Wellington

If inlation doesn't kill you in the first 15 years, you have enough income to meet all of your needs. If inflation kicks up, the rent on the paid off house can be increased to compensate. If that is not enough, the $100k property could be sold and either added to the portfolio or used to pay off the primary residence.

After about 10 years, move half of 401k account to Wellesely (again, for simplification, this could be a roll your own portfolio as well)
After 5 years (15 year mark) roll another 50% wellington to wellesely (25 % wellington)
Another 5 years (20 year mark) roll everything to wellesely)

Also at 15 year mark, as rental #2 is paid off either use the rent for income or sell the property (about $100k in todays dollars) and add this to the portfolio or pay off the primary residence.

Also at 15 year mark, start pulling divys and interest from the wellesley/wellington in the 401k.

around 65 or so start collecting social security.

Again, I don't plan on doing this right now, and these arent even my numbers, though the situation with the properties mirrors pretty close what i'm dealing with now.

Currently I hold a pretty typical tilted boglehead style portfolio poised more for growth than income.

I guess my question here is, would this work? It seems to cover almost all the basis including inflation protection. The biggest risk is the High Yield aspect, but what is really the risk here? Default risk resulting in permanently reduced principle and thus less yield? As long as the income holds pretty stable, the principle could fluctuate as much as it needed to.

Also, I didn't account for the other $50K. Some of this would likely be needed to pay capital gains when liquidating the portfolio, the rest would be held in cash as an emergency fund (say $25k or so).

Is this crazy or does it make pretty good sense? How much does the income from a fund like the vanguard high yield fluctuate over time?

Also, the current house could be downsized around 65-70 and probably get $100k in todays dollars out of it before buying a retirement home, so there's that possibility as well.

Comments? I know many would say just pull 3-4% out of a diversified portfolio and don't do this, but doesn't this (admittedly not conventional) plan solve the problem with sequence of return risk? Granted, I understand this would limit the upside growth potential, but assuming $40K more or less adjusted for inflation is more than adequate every year, who cares? Also, no need to leave an inheritance..

So if you made it through my long-winded rambling post, what do you think?

 

[mickeyd]

So, I was just daydreaming a bit and noticed something. This is an approach similar to what Scrabbler says he does, so probably not much new, just would like the boards take on it.

Let's assume a portfolio of about $1,250,000. Assume $400,000 in a 401k and the rest in taxable. Expenses in retirement are about $43K.

Portfolio: $1,250,000

I can't disagree with any of this.

 

[panhead]

I can't disagree with any of this.

HehHeh! I hit <tab> and my post went up before I was done! Check it now!

 

[ArkTinkerer]

I have several rentals and I view them as 1) diversification and 2) slightly higher return than stocks. The downsides are 1) not a very liquid investment if you need cash fast and the biggie! 2) ITS WORK!

The rest of your details are a plan but they center on the #1 advantage I listed--diversification. It is just another way to spread your risk around.

 

[jim584672]

I would be careful of any high yield bond funds. A lot have junk oil paper that can default if oil stays low.

 

[wolf]

I would be careful of any high yield bond funds. A lot have junk oil paper that can default if oil stays low.

+1, Agree. This is the weak link.

 

[haha]

The biggest risk is the High Yield aspect, but what is really the risk here? Default risk resulting in permanently reduced principle and thus less yield? As long as the income holds pretty stable, the principle could fluctuate as much as it needed to.

This is absolutely true. And as long as it doesn't rain, you will never need an umbrella.

Ha

 

[panhead]

I haven't tried to determine how much the 08/09 crisis affected the payout for this fund, that would probably be worth looking at. I was just kind of spitballing here to get a take on what people think. I know Scrabbler appears to be doing well with a similar strategy, but to be fair he did buy his fund at the bottom during the crisis which I'm sure gives him a huge advantage.

The only thing I *might* do at some point is add the High Yield fund into my portfolio at 10% of total portfolio value (about 20% of bond value). I know many here who follow Bogleheads aren't big fans of High Yield, but as my portfolio gets larger I think I would feel more comfortable with a slice of it.

I was having one of those "I don't want to work today" days when I was looking at yields and what might be possible. Sure looks good on paper, lol!

 

[Gill]

Default risk resulting in permanently reduced principle and thus less yield? As long as the income holds pretty stable, the principle could fluctuate as much as it needed to.

I always feel a bit uncomfortable with investment advice from someone spelling principal with an "le".
Bruce

 

[panhead]

I always feel a bit uncomfortable with investment advice from someone spelling principal with an "le".
Bruce

Good thing I wasn't giving advice then huh?

"I have nothing but contempt for anyone who can spell a word only one way." Thomas Jefferson

I always screw this one up. I remember the 'pal' at the end of principal and always think of a school principal and figure the one I want must be the other one.

 

[ArkTinkerer]

I always screw this one up. I remember the 'pal' at the end of principal and always think of a school principal and figure the one I want must be the other one.

"It's not the school I hate ... it's the principal of the thing!"

 

[Gumby]

Good thing I wasn't giving advice then huh?

"I have nothing but contempt for anyone who can spell a word only one way." Thomas Jefferson

I always screw this one up. I remember the 'pal' at the end of principal and always think of a school principal and figure the one I want must be the other one.

According to the Jefferson Library Spell a word only one way (Quotation) « Thomas Jefferson’s Monticello

We currently have no evidence to confirm that Thomas Jefferson ever said or wrote, "I have nothing but contempt for anyone who can spell a word only one way," or any variation thereof.

As Abraham Lincoln famously said "At least half of the quotes on the internet are totally made up."

 

[RetireBy90]

Back to OP, any plan you must ask what do I do if...
What if your high yield fund doesn't keep paying same dividend?
What do you do if you find you need some cash for [roof|medical|new car]?
What if inflation goes to 6%?

"Just some things to consider" Sam spade

 

[ArkTinkerer]

As Abraham Lincoln famously said "At least half of the quotes on the internet are totally made up."

You know there was no internet in Lincoln's time! Einstein said this. I have a link to it somewhere...

 

[Dash man]

Be careful with high yield funds. These are not treasuries and are not as liquid. When/if interest rates do rise and depending how sharply, these funds could run into a liquidity problem forcing a fire sale of their holdings. It could get messy.

 

[scrabbler1]

I haven't tried to determine how much the 08/09 crisis affected the payout for this fund, that would probably be worth looking at. I was just kind of spitballing here to get a take on what people think. I know Scrabbler appears to be doing well with a similar strategy, but to be fair he did buy his fund at the bottom during the crisis which I'm sure gives him a huge advantage.

Yes, I did buy my shares of the big bond fund at the end of 2008 when its NAV was nearly at its all-time low. This gave me about 25% more shares than I expected to buy when I was planning my ER budget.

What this did was create a nice surplus every month and enabled me to not have to use my other bond mutual funds I own to supplement the big bond fund's income. Or transfer a lot of money from those other bond funds (mainly munis) into the big bond fund. I did transfer some money from the munis, though, just not a lot.

Last year, thanks to declining monthly dividends per share which were not sufficiently offset by my increasing share balance, I began supplementing the big bond fund's income by taking as cash (instead of reinvesting) the quarterly dividends from a stock fund. This quarterly dividend had been between $1,200 and $1,500 most of the time but last year exploded to just over $8,000 total for the year. This quarterly boost to my monthly dividend income from the big bond fund is actually well timed because it coincides with my "lumpier" expenses such as income taxes, dental visits, and auto insurance.

 

[panhead]

You know there was no internet in Lincoln's time! Einstein said this. I have a link to it somewhere...

I love it!

Thanks for the comments all. Let me see if I can answer some of the questions. Inflation could be managed in several ways. Increasing rent on my rental property, selling my non-income producing property, and my thought was to hold onto my low rate mortgage and pay it with the interest from the HY fund. Also, 401k would be invested in a stock/bond allocation (Wellington in the example) and would hopefully grow in excess of inflation. After 15 years (about 60 yo) this could be tapped and would hopefully increase current income to make up for loss from inflation. Also at the 15 year mark, I will have another paid off rental property that could be sold and the proceeds added to the bond fund or used to pay off the house to further increase cash flow. Then in another 5 years Medicare kicks in (20 years from now) further reducing costs. Then the last decision is when to take SS.

The first 15 years would primarily rely on the HY fund. Also, the question was asked about lumpy expenses, I would also keep an emergency fund in cash, maybe $20k or more.

Again, I'm not planning on walking away from my current portfolio, but if I wanted to quit today, it seems like it might be a viable plan?

Realistically, the better decision is to w*rk a few more years and get to sub 3% withdrawal from my current balanced portfolio. I understand there's no free lunch, but damn, it was a fun back of the napkin exercise!

Scrabbler, thanks for sharing as always. I had forgotten that you have some stock funds in taxable as well. It was your posts that got me thinking along this path. Sigh... Time to get ready for work.

 

[MooreBonds]

Rental house mortgage free generating $5,000 a year in profit including maintenance and vacancies
another rental house with a 15 year mortgage covering all it's own expenses
Expenses are $43K in retirement with about $3K discretionary

What worries me is that you state the "other" rental house is paying its mortgage and covering expenses with its cash flow. What about vacancies/maintenance? Sounds like if/when you have a hiccup with the 15 year mortgage rental, it would siphon all cash flow - and then some! - from the other rental. There goes all your budget fluff, and also eats into your budget. That would make me nervous.

This quarterly dividend had been between $1,200 and $1,500 most of the time but last year exploded to just over $8,000 total for the year. This quarterly boost to my monthly dividend income from the big bond fund is actually well timed because it coincides with my "lumpier" expenses such as income taxes, dental visits, and auto insurance.

You didn't get $8,000 in dividends - you received about $6,000 in interest, with $2,000 in short-term and long-term capital gain distributions. Or, as more likely, even the previous $1,200-$1,500 quarterly distributions also may have contained capital gains (and would not recur in the future), given what rates have done over the past few years. If I were you, I'd devour the press releases from that fund to find out what the components are of the distributions regarding interest from the bonds vs short/long term capital gains that won't happen every year in the future. You should only count on the actual interest component of your distribution to happen in the future, not any return of capital or capital gain distributions.

 

[scrabbler1]

You didn't get $8,000 in dividends - you received about $6,000 in interest, with $2,000 in short-term and long-term capital gain distributions. Or, as more likely, even the previous $1,200-$1,500 quarterly distributions also may have contained capital gains (and would not recur in the future), given what rates have done over the past few years. If I were you, I'd devour the press releases from that fund to find out what the components are of the distributions regarding interest from the bonds vs short/long term capital gains that won't happen every year in the future. You should only count on the actual interest component of your distribution to happen in the future, not any return of capital or capital gain distributions.

Um, yes I did receive $8,000 in quarterly dividends from the stock fund. Until last week, the fund had not paid a cap gains distribution since early 2008, 7 years ago. That was mainly due to a capital loss carryover (a tough item to find in the fund's annual financial statement) which had finally been used up. For the bond funds, I am careful to separate the similarly lumpy cap gain distributions I always reinvest from the monthly dividends/interest.

 

[scrabbler1]

I love it!

Thanks for the comments all. Let me see if I can answer some of the questions. Inflation could be managed in several ways. Increasing rent on my rental property, selling my non-income producing property, and my thought was to hold onto my low rate mortgage and pay it with the interest from the HY fund. Also, 401k would be invested in a stock/bond allocation (Wellington in the example) and would hopefully grow in excess of inflation. After 15 years (about 60 yo) this could be tapped and would hopefully increase current income to make up for loss from inflation. Also at the 15 year mark, I will have another paid off rental property that could be sold and the proceeds added to the bond fund or used to pay off the house to further increase cash flow. Then in another 5 years Medicare kicks in (20 years from now) further reducing costs. Then the last decision is when to take SS.

The first 15 years would primarily rely on the HY fund. Also, the question was asked about lumpy expenses, I would also keep an emergency fund in cash, maybe $20k or more.

Again, I'm not planning on walking away from my current portfolio, but if I wanted to quit today, it seems like it might be a viable plan?

Realistically, the better decision is to w*rk a few more years and get to sub 3% withdrawal from my current balanced portfolio. I understand there's no free lunch, but damn, it was a fun back of the napkin exercise!

Scrabbler, thanks for sharing as always. I had forgotten that you have some stock funds in taxable as well. It was your posts that got me thinking along this path. Sigh... Time to get ready for work.

Panhead, it looks like you are splitting your ER plan into at least 2 pieces - the first is getting to age ~60 using only some of your assets, the ones you have unfettered access to. Then, after age ~60, you can begin tapping into some (eventually more) of your other retirement assets. That is my plan. I call those second set of assets my "reinforcements" such as (1) unfettered access to my IRA, (2) my frozen company pension, and (3) Social Security. I do not expect to exhaust my taxable account's money. Maybe I tap into some principal, principal which has grown by a lot since 2008 despite using its earnings every year since 2009 to pay my expenses.

I use my taxable account's stock fund as a partial inflation guard and to provide some supplemental income for my expenses. In my IRA, I have another stock fund which comprises about 50% of the IRA's total value. The (rollover) IRA's value has doubled since I ERed in late 2008.

I use one of my old muni bond funds as an emergency fund. I hate the idea of setting aside so much money in something which has pretty much zilch return. At least the muni bond fund, a fund whose balance I have lowered since I ERed (because I am in a lower tax bracket), generates about 2-2.5% return. I am willing to take a little risk in principal to get that 2-2.5%. It is an intermediate-term muni bond fund so its NAV doesn't bounce around a lot. And it is mostly tax-exempt. And it has checkwriting privileges which makes it easier to get money out if I need it, something which averages about once a year.

 

[2B]

"It's not the school I hate ... it's the principal of the thing!"

The principal of principal principle is an established principal in finance.

According to the Jefferson Library Spell a word only one way (Quotation) « Thomas Jefferson’s Monticello



As Abraham Lincoln famously said "At least half of the quotes on the internet are totally made up."

I had never heard the Jefferson quote before. I work with a lot of non-native language English speakers. I tell them you can't consider yourself truly fluent in the English language unless you can spell most words at least two different ways. They also have to watch out for words that sound the same or are spelled the same that mean totally different things.

 

[panhead]

As I said, this is more of a thought experiment than an actual plan of mine, but to answer some more of the comments…
The 2nd rental house covers all of it’s bills and leaves a couple hundred left over every month.I also have a separate line item in my expenses for additional maintenance and vacancies of both of my rental properties, so these expenses should be adequately covered.Very good point though.
Yes, scrabbler, I was looking at this as phase 1 and phase 2, with contingencies.If the HY fund with income from rental #1 could get me to the 60 YO mark, the rest looks pretty easy.As you say ‘unfettered’ access to retirement accounts open up, plus at that time, my 2nd rental would be fully paid off and the option to sell or take income from it presents itself.In a couple more years SS is available if needed, and in a few more years, medicade comes on line. Along the way I have some options to sell some property or downsize my current home to generate some more $$ if that ride from 45-60 isn’t very smooth.
My current plan is to build up my diversified portfolio and count everything as a whole.Then, take 2.5-3% draw based on the whole value. I “believe” that the HY bond fund plan would work, but I also agree with most of the coments here that the risks are substantial and currently my “buckets” aren’t overflowing.

 

[clifp]

Conceptually I like many elements of your plan.

When I was planning my retirement, my simple plan was to take most of my taxable portfolio and stick in California muni which were pay 5% at the time. My IRA would be invested mostly stocks and would be inflation hedge, and then social security would be available if everything went to hell, and on strippers, and fancy vacations if nothing went to hell.

But I never executed on the plan because as I learned more the diversification risk scared me. As it turns out there was a ton, I didn't know about muni which I found out the hard way.

The problem with your plan is the 800K in junk bonds. Brewer, is somebody who really knows his stuff about fixed incomes, and he was jumping all over them in 2009 and a year ago or so said to avoid them at all cost.

The collapse of oil price is could very easily be bad news for junk bonds, many are issued by 3rd tier oil companies and oil drillers. It would not take too long of $<50 oil for a lot of this guys to go under, and then the next run of junk bonds will be banks who made a loans to the same oil companies.

 

[2B]

The problem with your plan is the 800K in junk bonds. Brewer, is somebody who really knows his stuff about fixed incomes, and he was jumping all over them in 2009 and a year ago or so said to avoid them at all cost.

The collapse of oil price is could very easily be bad news for junk bonds, many are issued by 3rd tier oil companies and oil drillers. It would not take too long of $<50 oil for a lot of this guys to go under, and then the next run of junk bonds will be banks who made a loans to the same oil companies.

I own no junk bonds so take my comments with that in mind. I consider it an asset class that requires constant oversight. You just don't throw X% of your portfolio in to them and rebalance as needed annually.

Junk bonds are typically great when the underlying credit worthiness of these companies are improving. When falling, not so much. The other key is out of Investors Manifesto where Bernstein discussed failure rate. If the interest on normal corporate bonds are x% and the failure rate of junk bonds is y%, junk bonds make financial sense if junk bonds yield greater than (x+y)%. His comments were in regard to the 2008 meltdown where junk bond yields went very high. At a certain point, they made sense and that depended on an outrageous spread even in periods of increasing defaults.

I agree with your comment on 3rd tier oil companies being in trouble. I'm seeing the contraction first hand. Unemployment in the whole O&G and E&C world is getting hit big time. In a couple of months the principal GDP engine for the US is going to go the other way big time. The "recovery" in the last 5 years was primarily driven by this segment. I would not be surprised to see the US contract and possibly enter another recession.

People that got into the Houston rental house market in the last few years may get to relive in 1980s. What I saw then has been the basis for my continuing skepticism of individuals placing too many of their financial eggs in this basket. It went from "can't miss" to "can't survive" very quickly. I got to watch a few personal bankruptcies over it. Right now people seem to be saying that this will be a "mild" contraction but that's what was said back in 1984.

 

[Papa bear]

I own rentals as well and are big portion of my portfolio. Real estate and rents, however, don't necessarily track inflation from a micro perspective. Your locations could see great changes over time that could be a huge windfall or wreck your plans.

A real world example:

40 year time period:
Rental purchased in affluent suburb of major city. Rents increased with inflation for 15 years followed by 20 years of no nominal growth and only recently saw a huge increase as the suburb went from affluent to stable, to failing, back to hipster chic.