Planning And Investing For An Early Retirement (NYSEARCA:VNQ) (2024)

People at the age of 55 to 66, given the opportunity of a significant early retirement package, would most likely choose to take it. Due to many unknown variables in the decision making process, it would be hard to pass up a generous offer and take the risk of not having the same opportunity down the line.

In the past there was a common notion that retirement expenses are about 70-80% of those pre-retirement. But when considering the expense levels of early-retirees who are at the peak of their energy, who have hobbies (and sometimes expensive ones), who might have had their employer paying for many of their day-to-day expenses -- and now they are required to fund it all within their limited assets -- this statement doesn't hold anymore. I would estimate that, taking into account newly available leisure time, expenses could reach 130% of pre-retirement levels or even more than that.

So if an early-retiree would like to fund his required lifestyle, he must plan his steps very cautiously. While these early-retirement packages initially seem to be generous, it is very important for the retiree to make sure that he is taking the right steps to bridge the period left until official retirement age and therefore examine his new lifestyle and expense profile compared to his new projected income stream.

In order to bridge the gap to official retirement (or even to push it out as much as possible, to be entitled for higher Social Security benefits) sometimes people consider taking high risk actions.

Early-retirees should note that their primary income stream has changed and now they are solely dependent on their existing assets. People on the verge of early-retirement are sometimes overwhelmed by the amount of money they receive and are willing to take risks, like taking a second mortgage or buy another real estate asset to be used as an income stream. Taking on additional leverage could be catastrophic.

While the real estate situation varies from one city to city and state to state, jumping into a financial adventure where there is no alternative income source shouldn't be taken lightly. An alternative approach could be to invest in a REIT ETF that pays regular dividends and allows one to enjoy the return of the real estate market with robust diversification that somewhat minimizes local supply and demand risks while avoiding the hazards of dealing with tenants and carrying too much leverage.

VNQ as an example:

The Vanguard REIT Index ETF ( NYSEARCA:VNQ) tracks a market-cap-weighted index of companies involved in the ownership and operation of real estate across the United States.

The ETF is spread across 150 different holdings, which includes Commercial REITs alongside Specialized REITs and Residential REITs.

The ETF charges a yearly management fee of 0.12%, which is relatively low and among its biggest holdings one can find Simon Property Group, Inc. ( SPG) and Public Storage ( PSA).

Modeling the options:

Let's assume that the early-retiree was granted by a sum of $2,000 back in November 2014 and that whatever dividend he received throughout the years were reinvested back into the ETF.

The next table illustrates the investment cash flow:

By the 20th month he would have had a total of 26.4 units of VNQ which, based on 2015's $3.10 dividend per share, could be paying him $82 pretax per year.

Unlike a purchase of a real estate asset, which takes place in a single point in time, an investment in an ETF can be done in many instances across time and thereby reduce the risk of buying at the peak price.

The low interest rate policy that the Fed has implemented over the past decade has been very supportive to the REIT sector and this sentiment might change in the event that rates begin to rise.

We saw a first hike back in December 2015, but a weak economic situation, especially as regards employment and inflation in the first half of the year, thwarted promises of a subsequent four hikes in 2016.

Let's assume now that instead of a single purchase, the $2,000 were spread across 20 months together with dividend reinvestment.

By June 2016 the early-retiree could have 25.8 units which based on a $3.10 dividend per unit adds up to $80 per year. The fact that on average the ETF price was trending upwards during the investing period allowed the investor to purchase fewer units than the first all-in scenario starting day one.

When looking at the behavior of VNQ during the recent five years we can see that, indeed, it was trending upwards and therefore the best practice in hindsight was to purchase the ETF as early as possible.

Nobody had the crystal ball to tell us exactly how the ETF would behave in the future, but the early-retiree can define a more concrete criterion to his routine purchases.

Let's assume that the early-retiree would like to get a 4% pretax dividend on his investment. By using the $3.10 per year baseline one can calculate the high end of the range within which he would be willing to add more purchases in this ETF.

In this case the upper bound price should be set at $77.5.

In this case there were five months where the ETF price met the criteria of being lower than $77.5. By making these investments at lower prices (or at higher dividend yield levels) it allowed the early-retiree to invest the same amount of money, but to purchase a higher number of units. The 27.2 units would allow him to collect $84 pretax dividends based on the $3.10 yearly distribution.

When reexamining the 5-year graph of VNQ we can see that today it is near its all-time high. I would suggest following the algorithm of a predefined buy-price and patiently wait for it to come down.

Naturally, an investment in real estate ETFs is not risk free and any meltdown in the stock market could lead to a drop in REITs as well.

The next graph compares VNQ to SPDR S&P 500 Trust ETF ( SPY) during the last two years. VNQ is indeed more volatile compared to the entire market, but this also means that good prices could be coming soon for those who would patiently wait and act based on a predefined methodology.

VNQ has a long track record of rising dividends. No one can guarantee that it would continue, but the chances of obtaining growing dividend in the ETF are higher than the ability of a person to get his tenant to pay him higher rent every year.

In conclusion:

Early retirees should carefully plan steps after receiving their severance grant. Diversity is a great tool to avoid making an investment mistake that could cost dearly in the long run.

VNQ is one of the greatest tools for REIT diversity but one should predefine his entrance prices and work according to his plan cautiously and accurately.

Happy investing.

Ron Honig