I believe that in order to live the lifestyle we wish to live in early retirement; we will need roughly $7,500/month, or $90,000/year. I am very confident that this number will change over the next 5 years as we approach our early retirement date, but number is my best guess at this time. There are a few items I think about when considering how much passive income we’ll require at that time. Some of the main ones are:
- Tax rates of dividends and capital gains versus the tax rate my wife and I are paying while working full-time. Right now, dividends enjoy much better tax treatment than wages, but that could change in the future.
- Our future housing situation and city/state of residence. We are currently living in different cities, but plan to be living together again soon. We would like to buy a house when that happens, so we expect to have a mortgage payment, but the size of the mortgage will vary greatly depending on where we live.
- Health insurance once we are no longer working. Once neither my wife nor I are no longer on our company plans, we will have to find health insurance for the whole family, and it’s difficult to estimate how much that will cost five years from now.
At a 3% yield, $90,000 per year would require a portfolio of just about $3 million. That’s a massive sum, and seems pretty daunting right now, but that’s what we’re shooting for.
As for a portfolio to accomplish this 3% yield, it would have to be something like the one shown below. It is 60% in common stocks (VTI and VXUS), 12% in preferred stocks (PFF), 15% in bonds (VCIT and VGIT) and 13% in real estate (VNQ). You can see from this sample allocation that I am more interested in low-cost ETFs rather than stocks in building up my portfolio. This is largely due to my background as an equities trader, and a lot of academic research that has shown how difficult it is for fund institutional managers to beat the market over time. That being said, I do currently own a few individual stocks that I have generally bought at what I believed was a discount after news events that hurt the price of the stock without (in my view) negatively impacting the long-term value of the business.
There are certain tax considerations I will have to keep into account as we begin building toward a model similar to the one below. For instance, the dividends provided by the corporate bond ETF I chose (VCIT) are not qualified dividends, and are taxed at a higher rate than dividends from regular stocks. The REIT dividends from VNQ are also taxed differently than traditional dividends. We will look more into tax efficiency and optimizing the portfolio for taxes as we get closer to the tipping point, since tax laws may be slightly different in 5 years compared to now. More to follow on asset allocation in coming posts, especially as we approach 2021.
How about you? What does your early retirement portfolio look like?