How to start long-term investing for early retirement

by Ivan Mir on Feb 20, 2018

Disclaimer: Since writing this article, I've changed my outlook on the future. After studying various sources, I expect the market to stagnate in the following decades and won't stay in it for long. See the last section of another article of mine for the details.

Early retirement doesn’t require a huge salary — you can achieve it with a moderate income and thoughtful spending patterns. The most reliable way to get there is long-term investing in markets. Starting an investment portfolio might seem overwhelming, but once you get through the heaps of financial jargon, the process turns out to be pretty straightforward.

This guide describes a safe long-term investment strategy that

  • has proven effective over the last 40 years;
  • is heavily endorsed by Warren Buffett;
  • doesn’t require any serious knowledge about the markets; and
  • can be started in less than a week with $2,000-$10,000.

Additionally, I wrote tips for readers like me who live outside of the United States and can’t use most investment guides because they’re focused on U.S. residents. So you can use this strategy from almost any country.

The big picture

The core idea behind the safety of long-term investment is that markets grow in 15-20 years, even when there are crashes and recessions. In some years, your investment returns may be zero or even go negative, but over long periods, you will have a 4% yearly return on average. It works well even for actual pension funds — in most countries, your retirement contributions are also invested. So long-term investment is basically building your own pension fund.

Here’s a somewhat realistic case for many developed countries:

  • Earn a $36,000 net income each year ($3,000 a month).
  • Spend $24,000 of that ($2,000 a month).
  • Invest the remaining part, $12,000.

This way, you will be able to retire on your own in 25 years — a bit long, though still earlier than most people. But if you are fortunate enough to earn $60,000 a year while living in the same inexpensive place and spending $24,000 a year, then you can retire in just 12 years. This happens because the larger percent of your income you save, the closer your retirement is; increasing your savings from 10% to 20% leads to a retirement 14 years earlier.

In the examples above, you will eventually get to $625,000 of worth, which on average returns $24,000 yearly in passive income. Remember that cutting your expenses works much better than trying to increase your income because it both improves your savings rate and decreases the total amount you need to start living from returns. There are useful sites like Mr. Money Mustache about optimizing excessive spending and living more frugally than the average person.

Modern investing approach

So you buy a public company’s stock and become a shareholder, one of the company’s owners who has a right to dividends — that is, a part of the profits. The cost of the company’s shares is a reflection of how much it earns already and the market‘s collective forecast of its future profit growth. But choosing companies to invest in by yourself would be like playing the lottery with your savings — even very intelligent people usually don’t have enough time and experience to allocate their portfolios properly.

The traditional way to resolve this was by investing into mutual funds, which hold shares of hundreds of companies at once. These funds employ managers who try to achieve the best profits by watching markets and trading shares according to their forecasts. The problem is that many mutual funds perform worse than markets on average. But even if a mutual fund is successful, it still takes a huge cut from your returns to pay its managers.

In the 1970s, John Bogle suggested that trying to predict markets works no better than just mimicking them. For example, if the current valuation of Apple is 2% of the total valuation of all S&P 500 companies, then a fund based on the S&P 500 market index should allocate 2% of its money into Apple’s shares. Then if S&P 500 grows 10% in a year, the fund also grows 10% — it performs exactly as its market while keeping the costs low, because mimicking is simple compared to active management.

This solution is called "index fund," and it’s usually structured as an ETF (exchange-traded fund). History shows that Bogle was right — for over 15 years, indexes outperformed 92% of actively managed funds. Nowadays, his own investment company, Vanguard, holds over $4 trillion in assets, and his investment philosophy has a huge following (e.g., the Bogleheads online community).

Managing risks

But which market to choose? That’s the easiest decision — all of them. There are popular ETFs that track thousands of companies of different size in different industries and countries. So you are investing in the whole world’s economy, spreading your risks all over the planet. While it may be not the fastest-growing option, it’s definitely one of the safest ones when it comes to stocks.

Still, bad times happen — like worldwide crises and stagnations that affect growth-oriented stock markets a lot. This is why we should balance our portfolios with bonds. A bond is basically a loan: buying bonds from a company or government means you lend money to them for an interest. While interest rates aren’t that high compared to stock returns when markets are doing well, they will still be profitable when markets go down or stagnate.

So stocks bear higher risk and higher reward, while bonds are low-risk and low-reward (well, there are risky "high-yield" or "junk" bonds, but let’s ignore them). John Bogle himself recommends a "roughly your age in bonds" allocation rule, but there’s a popular opinion that you don’t need bonds at all if you are still in your 20s or 30s — you have a lot of time until your retirement, so you can wait through a market downturn.

Picking bonds is also easy — half U.S. Treasury and half U.S. corporate bonds is a good ratio because they are high-quality, and their ETF expense ratios are low.

Building the investor’s mindset

Investment is not speculation. We should never try to "time the market" — that is, predict the price and trade at the right moment. This includes waiting to start investing because everybody says that markets are overvalued and the crash is near. If you look at historical returns, the most unlucky folks who invested a lot right before crashes would still end up with huge profits over many decades. The economy is a sequence of contractions and expansions, so focus on the big picture.

Since we are talking about really long periods, the iron rule is "stay the course." Don’t watch financial news, don’t check your portfolio more than once a month (even if it’s 2008 all over again) — just invest while stocks are cheap, and wait for the next cycle of growth. Treat the invested money like it’s a real pension fund — imagine that it’s not available until your retirement, so there’s nothing you can do even if the markets are in a free fall.

It’s really important to stay consistent and never get reactive. Invest early, invest often and stick to your plan.

Avoiding U.S. taxation

While you can find many recommendations of "lazy" portfolios in Bogleheads wiki, don’t pick them if you are not a U.S. resident. (If you are, you can skip to the next section.)

ETFs can be "domiciled" in different countries, and the most popular ones are domiciled in the United States. But as a nonresident, you must pay 30% tax on dividends unless there’s a lower rate in the tax treaty between your country and the United States. Luckily, nowadays, Vanguard and some other companies also have ETFs domiciled in Ireland, so here is how it works:

  • U.S. taxes are paid by your Irish fund, according to the US-Ireland tax treaty.
  • Unless you reside in Ireland, you are not subject to Irish taxes either (including the inheritance tax).
  • You can buy ETFs in Euro, British pounds and Swiss francs without losing money on conversions into U.S. dollars.

The downsides of Irish ETFs are lower diversification and slightly higher expense ratios, but they are still the best option for the majority of cases. See this article for more details on nonresident taxation in the United States.

Choosing ETFs

I focus on Vanguard’s ETFs, but there are similar index funds from other companies available both in the United States and the European Union.

U.S. residents

While there exists Total World Stock ETF (VT) that includes both U.S. and international stock, it’s usually recommended to combine half of Vanguard Total Stock Market ETF (VTI) and half of Total International Stock ETF (VXUS) instead because of

  • broader diversification (7,985 stocks in VT versus 9,921 stocks in VTI + VXUS);
  • lower expense ratio (VTI costs 0.04%, while both VT and VXUS cost 0.11%); and
  • size (VT is just $15 billion, but VTI + VXUS is almost $1 trillion).

For bonds, it’s simple: Total Bond Market ETF (BND) will do the fixed-income thing perfectly.

International residents

The U.S. portfolio above has two funds responsible for stocks and one for bonds, but the composition of Vanguard’s Irish ETFs is one fund for stocks and two funds for bonds. In practice, it’s not significant for your investments:

These ETFs are available in multiple currencies and traded on multiple stock exchanges in European countries:

  • London Stock Exchange — GBP, USD
  • NYSE Euronext — EUR
  • Deutsche Börse — EUR
  • SIX Swiss Exchange — CHF

Because of this fragmentation, they also have different stock tickers (you can find all tickers by clicking on "Fact Sheet" on the funds’ profile pages):

So if a lazy three-fund portfolio for a U.S. resident looks like this:

Then an international equivalent looks like this:

But as we discussed earlier, if you are in your 20s or early 30s, you can postpone bonds and allocate 100% into the stock ETF for better growth.

Update 2019: Vanguard UK launched accumulating bond ETFs that reinvest their dividends but they are not available in EUR so far. Accumulating ETFs are more tax-efficient, so if you invest in USD, GBP or CHF I would recommend VUTA/VDTA instead of VUTY/VDTY/VGTY and VCPA/VDPA instead of VUCP/VDCP.

Any other options?

Many people allocate a significant amount into the S&P 500 index, but Total Stock Market ETF and FTSE All-World UCITS ETF already include S&P 500 companies. This index also contains a lot of tech companies, and since I already work in tech, making both my income and investments depend on it too much is a poor diversification.

If you live in a politically stable country with an economy that grows faster than the world on average, investing a bit in the local market could be an option — but don’t overdo it because your government pension also depends on your country’s economy.

In my case, I allocated 20% in the Chilean market — it’s convenient for me because I have some capital in Chilean peso. But I consider this investment risky, so in future I will shift allocations to create a bond-secured portfolio:

Age 30+ 40+ 50+ 60+
All-World 80% 55% 40% 35%
Risky 20% 15% 10% 5%
Bonds 0% 30% 50% 60%

Where to go next

Good luck with your investments, and remember to stay the course regardless of possible temporary losses!

Bonus: international brokers

This is one more section for non-U.S. residents because local brokers in many countries are expensive and often don’t have access to the Irish ETFs we need. Americans can study their alternatives to Vanguard at Bogleheads wiki.

Here’s a short overview of two brokers that consistently work with non-EU residents. Europeans can find more available brokers and detailed comparisons at Brokerchooser.

Interactive Brokers

https://www.interactivebrokers.com

Pros:

  • The lowest trading fees among brokers.
  • No minimum to open an account.
  • Works for almost every country and offers support in many languages.
  • No physical offices — everything resolved online.
  • Really big: founded in 1993, holds $55 billion in assets.
  • Easy to set up joint account for a family.

Cons:

  • $10 minimum monthly fee until you reach $100,000 in equity. Not anymore, IB removed monthly inactivity fees in 2021.
  • Only wire transfer is available for deposit from most countries.
  • Slow account-opening process (but they speed up if you send the money) and slow support responses.
  • If you have an account in the U.S. branch as a nonresident, you should keep less than $60,000 in cash to avoid the U.S. estate tax.

Due to U.S. legal requirements, Interactive Brokers ask you during the application if you have at least $40,000 yearly income, $20,000 net worth and enough trading experience (over one year and 100 trades). Unfortunately, many fresh investors have to lie at this step.

Saxo Bank

https://www.home.saxo

Pros:

  • Can be funded by credit or debit card for 0.45% to 2.78% (depending on the currency).
  • Based in Denmark, with offices in Prague, Amsterdam, Geneva, London.

Cons:

  • Yearly custody fee: 0.12% of your total portfolio worth.
  • Higher trading fees — starting at $12.
  • $2,000 minimum to open account from the EU but $10,000 from most other countries.
  • A personal account can’t be converted into a joint account later.
  • Latin-American residents can’t open an account directly, only via Saxo’s local partners.

Local brokers

Sometimes you can find a decent broker in your country of residence, but check for the following:

  • Access to the stock exchange, where you can buy Irish-domiciled ETFs (usually London Stock Exchange is the best option).
  • Trading fees — long-term investors don’t trade often, but high fees still burn your pocket.
  • Inactivity fees — while we should invest a bit each month, inactivity fees should be tolerable in case you won’t be able to invest for a year or so.
  • Custody fees — could look tiny (like 0.12% yearly), but later it will be a significant amount of money.
  • Economic and political stability — can your investment be safe for over 50 years in your country?

Illustrations by Irina Mir

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