Now that we are saving a bunch of money with our high savings rate, what do we do with all that money?
The answer is simpler than you think: invest it in low-fee index funds. There are a bunch of these, and it doesn’t really matter which you choose so long as the fees are low – Vanguard’s VTI or the “Total Stock Market Exchange Fund” is the gold standard. It also doesn’t matter whether these funds are in a company-sponsored 401(k) plan, a brokerage account, or an automatic management service like Betterment as we use. The crucial thing is that you’re purchasing parts of real, profitable companies that pay dividends and appreciate over time.
If you’re looking for an uncomplicated strategy, “The Simple Path to Wealth” by J.L. Collins is an excellent book that convinces you that this simple method is also the best method. His stock series is also an excellent resource.
Execution: Turning Savings into Income
Let’s see how this works with a hypothetical – you’re 34, have saved up a million dollars, and have just handed in your resignation. You have two significant chunks of money – a taxable account and a retirement account (like a 401k, IRA or a pension).
Step 1: Use the taxable account first. On day one of your retirement, log into your account, find the dividend option, and set it to automatically deposit into your checking account. Assuming half of your funds ($500,000) are in a taxable account invested in VTI, with an average dividend yield of 1.3%, you could expect a yearly dividend income of around $6500.
Step 2: To reach your annual expenditure of $40,000, set up auto-withdrawal of the remainder, and have your checking account set to automatically pay your credit card, which you use for daily expenses. You may be losing shares yearly due to withdrawals, but thanks to the natural stock market growth, each remaining share will be worth more, ensuring your money lasts longer than it would in a checking account.
Step 3: 25 years later, at 59, you’re eligible for penalty-free withdrawal from your retirement account. But during those years, your untouched retirement account has grown from $500,000 to approximately $1.4 million, adjusted for inflation. That’s more than enough to live comfortably for the rest of your life.
The division of your investments doesn’t matter, the total amount does. For instance, if a $1 million house is a large part of your net worth, consider selling it, investing the cash into index funds, and using the cash stream to rent or buy a reasonably priced house in an area of your choice. If your taxable account is small but your retirement balance is large, look into options like a Roth conversion ladder to tap into it sooner.
Health Insurance and Other Concerns
The first thing that often comes to people’s minds when we talk about quitting our jobs and living off our investments is health care. To start, adopting a healthy lifestyle – eating clean, exercising regularly, and generally living an outdoor, non-car focused existence can eliminate “lifestyle diseases” that trigger more than 75% of healthcare spending in the U.S. Quitting that job that requires you to sit inside staring at a computer 12 hours a day is a great place to start.
Beyond that, the Affordable Care Act has made health coverage more affordable than many people realize. If we go to the California equivalent of healthcare.gov right now (choose your relevant state of residence) and put in a hypothetical 4-person family with a $40,000 annual income in my zip code, it looks like we are fully covered by Medi-Cal. However, if you bump your income up to $41,550, we get $111.88 per month.
This represents a $650 per month reduction relative to what a high-income family would pay. In other words, the U.S. now has a progressive tax system like in other rich nations. It’s not perfect and likely has a high deductible, but it won’t bust your retirement and based on the retirement accounts discussed above, we will have the money to pay for that deductible.
Other common fears are stock crashes and rising costs of living. It’s important to remember that stock crashes aren’t permanent. The market always goes up in the long run. During those short periods when the market is down, selling shares will hurt you a bit more, but within a couple years the market will be back up and your remaining stocks will be even more valuable. If you want some increased insurance, just spend less money during those downtimes.
As for inflation, it rarely outpaces average income growth. But if it does, spend less in other areas. We are in control of this stuff, and we have a long runway to make corrections if we need to as we will see if our money is going to run out decades in advance. Stay adaptable and willing to make lifestyle changes as needed and you should be fine.
People also often bring up the cost of raising children. I plan on getting into this much more in later posts, but it seems like kids are not that expensive if you avoid the pitfalls of “Ivy League Preschool Syndrome” – the unnecessary stress and financial burden parents place on themselves and their children in pursuit of prestigious (and often costly) education, driven by societal pressure and the perception that this will guarantee future success. Not only does the cost of their food, education (free), and healthcare start out low, but it also seems subsidized by the fact that raising kids takes so much time that it keeps us parents from spending money on ourselves!
The Bigger Picture
The key is to get the big picture approximately right and not worry too much about the small stuff. There is a lot of slack in this design on purpose. Our model doesn’t factor in Social Security benefits, incidental income such as an inheritance, or profits from post-retirement work. Remember, working hard every day in retirement is good for you, and as a productive member of society, some of that hard work is likely to result in some form of income even in retirement.
In conclusion, a well-managed chunk of money is a robust retirement plan. If you get the numbers right, you’re set for life, irrespective of age. Indeed, this strategy is safer than relying on a job, where a minor dip in the economy, or the business plan, can cause the boss man to show you the door. By contrast, a well-diversified investment portfolio just needs the world economy to continue functioning. Embrace this approach, and enjoy the security and freedom it brings to your retirement years.
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