The Dream of Early Retirement
At this very moment, my wife and I could quit our jobs, sell our house, and head to a low cost of living locale, enjoying the rest of our lives on passive income (albeit at a very low standard of living). It wouldn’t be the completely fulfilling retirement that we discussed, but this Bare Minimum FI does provide a sense of empowerment, resonating through every current decision we make.
For instance, below are a list of a few examples of low standard of living locations across the world and their total costs for two people (per Forbes):
Portugal - $2,200/month in total costs
Panama - $1,700/month
Costa Rica - $1,800/month
Mexico - $1,500/month
Colombia - $2,000/month
Ecuador - $1,000/month
Malaysia - $1,500/month
Spain - $2,000/month
France - $2,500/month
Vietnam - $1,000/month
Crazy to think that we can live in Portugal for $2,200/month or $26,400 per year.
What Does Our Passive Income Need to Cover?
But truly the goal for us is to earn enough passive income to cover our expenses.
Our largest expense is our house, which we anticipate to be paid off by the time we retire. Any way we look at it, the house will be an eliminated expense because we can (1) live in it rent free (although taxes/insurance/maintenance still cost some $$$), (2) sell it and wrap it up into investments that generate more income for the next living situation, or (3) rent it out and use the cash flow to pay for the next living situation.
So now we just need to have our passive investments cover all of our other expenses. We might still relocate to a low standard of living country (one of my favorite YouTube channels “Our Rich Journey” discusses how they retired in Portugal, which you can also read about on their website by clicking here), but the goal is to plan for the high end of the range of FI (or what I like to call Full FI) to give us optionality.
Two Routes to Have Passive Income Pay for Our Retirement
The world is full of passive income ideas. But in the end I stick to my strengths and invest our income in stocks. I enjoy it. And to me it requires less work to start up and keep up with, especially versus other routes. In terms of investing, I have two distinct options:
(1) Create a portfolio whose value is large enough that some of the portfolio can be sold each year to cover all of our expenses
The 4% Rule stemmed from this idea. The basic question researchers at Trinity University asked was “what percent of your portfolio could you live off of for at least 30 years?” They back-tested 4% (and other percentages) through history and only in a couple of historical scenarios did it not last all 30 years. I don’t know about you but a 99% probability is certainly high enough for me. On a recent podcast, the man responsible for the 4% Rule stated that 4% might actually be too low today, which gives me even more comfort in the 4% rule for early retirement.
So I would need to build a portfolio that allows me to sell 4% of the investments each year, while the portfolio itself continues to grow. The S&P 500 has historically averaged 8% returns since it adopted 500 stocks in the index. So even if I take out 4% from my portfolio, the portfolio will still return 400 basis points more each year on average (remember it is “on average” because some years it might be much higher and some much lower).
For example, if our expenses were $50K each year, then the portfolio would need to be $1.25 million ($50K / 4% = $1.25 million). To get to $1.25 million, my wife and I would need to save and invest $46K each year for 15 years (at the S&P 500 rate of return of 8%). Changing the timeframe, amount saved, and market return can drastically change the numbers overall, but even if it doesn’t work out, my wife and I would still be closer to retirement after 15 years in this example, than we would have been when we started.
Or option 2…
(2) Create a portfolio of companies that pay enough in dividend cash flow to cover the expenses
Dividends = dollar amount per share that is paid by the company to the owner of each share of the company’s stock.
The company is able to pay the dividends to the shareholders because they themselves are exhibiting cash flow strength in the business. So if I own 100 shares of a company’s stock and the company decides to pay out a $1/share dividend, then upon the payout date I will receive $100 from the company in my brokerage account.
In order to cover our expenses, I would need to make sure that the amount of dividends being paid out from the companies in our portfolio is equal to or greater than our yearly expenses.
Side Note: Companies that pay dividends normally highlight their dividend yield, which is calculated by taking the total amount of the dividends being paid out for the year and dividing it by the stock price. Think of the dividend yield as the stock’s interest rate.
In a recent article, I discussed my new investment in Simon Property Group, or SPG. Their dividend yield right now it 4.2% (dividends for the year of $5.20 divided by the stock price of $124). Because each share of stock pays $5.20 in dividends, I can then calculate how many shares of SPG I would need to buy to cover our yearly expenses. Using the $50K example above:
$50K divided by $5.20/share = Shares Needed
9,615.4 shares of SPG are needed to cover our yearly expenses. This equates to $1.17 million (if you multiply the shares needed by the current price of the stock).
At first glance, option 2 seems better: (1) $1.25 million needed to retire versus (2) $1.17 million needed to retire. But the dividend could be cut or eliminated if the company hits hard times and isn’t cash flowing like they were before (see General Electric, Disney, etc.).
One way to mitigate this risk is by investing in a dividend paying ETF that contains many stocks, so if one cuts their dividend, then you still have the others to offset the loss. ETFs do have an expense ratio to pay for the management of the portfolio within the ETF, so be cognizant of the fees being paid and the actual dividend rate.
Another option is to diversify your own portfolio holdings with dividend paying companies. For instance, the following 10 companies all pay dividends (and 387 of the S&P 500 companies pay dividends):
Starbucks
Target
Home Depot
UPS
Bank of America
Microsoft
Verizon
Chevron
Walmart
Intel
What Option Are We Choosing
If you have noticed my portfolio recently, it is largely growth companies. I am trying to get to an initial 70% growth and 30% cashflow split with my portfolio.
Each year that we get closer to retirement, I will invest less in the growth companies and more in the cashflow companies. The thought process is that those growth companies over the years will become stronger and more profitable (potentially paying a dividend themselves), and the dividend companies will offer more stability and cash flow.
As with Simon Property Group, I still want to believe that they have the potential for capital appreciation over the years, so I don’t just focus on the amount of dividends they pay but also their potential runway for growth. Growth for the business overall can also buoy the dividends being paid out. As the company makes more money, they have the tendency to pay out more dividends to shareholders, so what is $5.20/share for the year in dividends with SPG could be $8.00/share in 7 years.
But just in case, we will have some built-in safety nets.
Built-in Safety Nets
Cash account to cover two years of expenses to bridge any market downturn (large market downturns average 18 months).
Eat well and workout to try to minimize healthcare expenses.
Early retirement means we are still young enough to jump back into the workforce if necessary (temporary contracted work as a UPS driver during the holidays or with the IRS during tax season pays pretty well).
Potential income from passion projects or part time work during retirement.
Preparation of two budgets: (1) for normal expenses, (2) for bare minimum of expenses.
Any number of surprises or changes could occur in our future. A family. A medical emergency. A lost job. My plan could blow up thanks to a surprise (thus delaying our retirement another x number of years), but regardless, we would still be able to weather any surprise better with our current plan than without.
Maybe Early Retirement Is Not For You…
Try “Coast Financial Independence or Coast FI”
If you read the above and thought, “I don’t want to retire early,” then maybe something called Coast Financial Independence or Coast FI is the path for you. Coast FI is simply saving/investing enough money early to allow those initial funds to grow over time so they will support you in retirement without the need to save/invest any additional funds later.
Let me break this down with an example:
Joe is 25 and wants to retire at the normal age of 65. He anticipates needing $1 million in retirement (4% rule means he has $40K in expenses to cover each year).
*Kind of seems like I’m setting up a math equation from high school doesn’t it.
If Joe saves $6.9K each year until he turns 35, then he would have ~$100K. That $100K on its own with no other cash additions and invested in the S&P 500 would turn into $1 million by the time he turns 65. So at 35 with $100K invested, Joe would be considered Coast FI. He can now “coast” into retirement without having to save another dollar.
Of course, there are always risks, life style inflation, etc., but the potential is there for Joe to work and spend his entire salary while letting the $100K grow from age 35 and on.
If you want more details on Coast FI, then google it. Articles galore explain it in detail.
Thank You!
If you’ve made it this far, then you are an amazing human. Let me know what you think by leaving a comment. Or drop me a question. Share it with others who you think might appreciate the information. Looking forward to sending out the next issue!
**I am not a financial advisor, so please don't buy/sell anything based solely on what you read here and do your own due diligence.