This article was first posted February 1, 2000.
Retire Early has yet to review a book that gets essentially everything right on the subject of early retirement, but Gillette Edmunds', How to Retire Early and Live Well comes very close. This is a very personal book by a former tax attorney and journalist who retired in 1981 at age 29. He details what he has learned about "living off his investments" and provides some personal examples of how to ride out the ups and downs of the market.
The first chapter "Can You Retire Today?" shows you how to calculate how much you'll pay in taxes, how much accumulated capital you'll need, what to expect in terms of inflation, and finally, how much you can safely withdraw from your portfolio in retirement. The author's formula for calculating your "targeted investment return" is your annual withdrawal as a percentage of assets plus inflation. So a retiree drawing $50,000 per year from a $1 million portfolio who assumes inflation is 3%, will need an 8% targeted investment return. That's not much different than most of the studies I've seen pegging the "95% safe" inflation adjusted retirement withdrawal at no more than 4% to 5% of assets for an equity/fixed income portfolio. Edmund's writes, "There have been hundreds of studies over the years of returns for different asset classes." (p. 51) Yet, he offers no references to support his recommendation of an "8% targeted investment return" from a portfolio of "three to five noncorrelated asset classes." This is one of the few shortcomings of the book.
Chapter Two discusses several early retirement pitfalls like "outliving your nest egg", the burden of taxes, and the difficulty of finding a trustworthy investment advisor. Retirees will greatly benefit from heeding these warnings.
The third chapter discusses the question "How Much More Do You Need?" Edmunds point out that investment returns, rather than sophisticated tax planning, are they key to how early you'll retire. He also points out that "too much house" and "too much stuff" can also keep you from retiring early. Your personal residence, furnishings, automobiles, and other "toys" are not income producing assets that you can use to fund early retirement. If you have "too much house" the author advises to "downsize now and invest the excess in a retirement portfolio." (p. 35) You want to avoid the rush at some later date when your fellow baby boomers attempt to do the same.
Chapter Four "Designing Your Retirement Portfolio" is the centerpiece of the book. Edmunds advocates retirees hold "three to five noncorrelated asset classes." That's probably more diversification than most people have. Like Warren Buffett, he counsels that "often investment success is the result of continuous inaction." (p. 62) and that "living off principal is the ultimate tax shelter." (p. 65)
The fifth chapter discusses "U.S. Stocks, Large and Small" as an investment. Since just about every American is familiar with this topic, the best part of this chapter was Edmunds discussion of how to select a "money manger." While he spends considerable time with an excellent description of how to go about finding a "money manager," he wisely advises that most folks will do better just buying an index fund.
The next chapter covers "Foreign Stocks and Emerging Market Stocks." I would have liked to see more emphasis on the pitfalls of "emerging markets." While we have our share of "white-collar criminals" in the U.S., the level of corruption in many third world countries make them dubious investment opportunities. Investment titans from Warren Buffett to Vanguard's John C. Bogle see little reason for Americans to venture overseas with their investment dollar. Still, author Edmunds makes a strong case for having up to one-third of a retirement portfolio invested in foreign markets. He also points out that management expenses are much higher for international mutual funds and that index funds aren't the "sure bet" in foreign markets that they are in the U.S.
Edmunds covers real estate in Chapter Seven. He correctly points out that REITs are more correlated with the stock market than holding individual properties. (p. 127) He warns against the use of excessive leverage in buying real estate and soberly points out that "low leverage [i.e. 50% or less] increases chances of a 10% return." (p.129) He does an excellent job detailing what's required to analyze a potential real estate investment. The author also points out that a diversified real estate portfolio contains a minimum of three properties (p. 142) often in in different cities. Stock index fund investors will quickly recognize it's a lot more work than opening a mutual fund statement at the end of the month. In the last paragraph of the chapter Edmunds summarizes, "Individual properties are a superior asset class for retired investors. But they require substantial time and attention." (p. 162)
In Chapter Eight Edmunds discusses the world of fixed income investments. He quickly focuses on the major advantage of U.S. Treasury bonds -- they are "the best deflation investment." (p. 165) The standard warning to avoid bond funds appears later in the chapter. (p. 186)
I don't have an LLM in Taxation from NYU like Mr. Edmunds, but I believe he made one small error regarding the taxation of interest on a Certificate of Deposit (CD). Edmund's writes,
"The interest on both standard CDs and brokered CDs is not paid until the CD matures. For tax purposes, there is no tax liability until interest is paid. Thus you can defer taxes on the interest for the length of the CD plus the number of months until your estimated tax payments or final tax payments are due." (p. 175)
According to J.K. Lasser's, Your Income Tax 2000 (p. 77) , interest that is deferred to maturity on a CD with a term of more than one year is considered to be an original issue discount (OID.) A portion of the OID is reported to you by the issuer as interest income on Form 1099-OID. So there appears to be no advantage in deferring the interest payments on a multi-year Certificate of Deposit.
Chapter Nine, "What Else Works" discusses alternative asset classes. He quickly dispenses with "ego investments" like venture capital funds and "hedge funds." He humorously points out that the easiest way to make money in a hedge fund is to start your own. (p. 197) The promoters of these schemes make far more than the clients.
I particularly liked Edmund's advice for retirees buying a small business:
"It is possible to make a fortune from a small business if you put in enough time and have enough luck...When you have the option of spending as little as ten hours a week monitoring your investments, why are you choosing to work sixty hours a week [in a small business]? Before you buy a small business, go to at least ten meetings of Workaholics Anonymous and go to at least ten therapy sessions with a therapist who specializes in workaholism. Twenty opportunities to tell the truth about how desperate you feel are worth more than any profits you could make from buying a small business."(p. 200)
The author appears to favor oil & gas properties, but warns that fees and commissions on these types of investments are difficult to minimize.(p. 203) He also notes that U.S. Treasury Inflation Indexed Securities (TIPS) carry a host of disadvantages, though they may be appropriate for some retirees. (p. 205) The chapter ends with the very astute, and time honored advice to avoid annuities of any species or description. (p. 206)
Chapter Ten "Designing Your Growth Portfolio" highlights the importance of diversification. The author's warnings that the U.S. stock market is "too high" and that "Japan could happen here" are certainly well taken. Edmunds prudently advises investing no more than 1/3 of your retirement portfolio in U.S. stocks. (p. 212) Unfortunately, most early retirees I know got to where they are with 100% U.S. stocks -- often times with a portfolio of just one stock -- their employer's. It will be tough to persuade this group to diversify.
Edmunds has a more generous view of hiring investment advisors than I do. (p. 218) I continue to believe that investors are well served by cutting expenses to the bone and doing a much as possible themselves. I second his advice regarding "dollar cost averaging" -- don't wait, invest the lump sum today. (p. 220)
Chapter Eleven, "Investing for Growth" details Edmunds thoughts on identifying activily managed mutual funds with some chance of beating the market. The last half of the chapter is a comprehensive discussion of real estate investment trusts (REITs) and REIT mutual funds. Edmunds issues the proper warning that adding this double set of management expenses (in the case of REIT mutual funds) is not preferable to owning individual properties. (p. 247)
The last chapter "Living Through a Crash Without Putting a Bullet Through Your Head" is a very personal account of Edmunds experience over the past 20 years. While there are few people still alive that weathered the "Crash of '29" those of us who experienced the "Crash of '87" will find the emotions Edmunds describes familiar.
All in all How to Retire Early and Live Well is an excellent book and offers some very thought provoking ideas on the merits of diversification. It's one of the few volumes that merit 5 Stars from Retire Early's reviewers.