MONEY Investing

Winning at Investing Made Simple

Served on a silver platter: the right portfolio strategy and investing well for retirement. illustration: tavis coburn

Here are just a few of the ways Wall Street pros try to eke out an edge in the market. You can’t do any of them:

With a subscription to the Bloomberg online news service (price: about $20,000 a year), traders can instantly see anything from the location of oil tankers around the globe to supply-chain maps of a company’s vendors and customers.

Hedge fund managers who invest in drug and technology companies tap into “expert networks” of executives and scientists paid for their specialized knowledge. In some cases, it’s been charged, traders have also illegally gotten inside information through these contacts.

Half of stock trades are made by automated “high-frequency” programs; it takes 7/10,000ths of a second to buy or sell on the New York Stock Exchange, says the Tabb Group, down from a horse-and-buggy 10 seconds eight years ago.

You can’t get a jump on this crowd. You can’t even compete with them. Chances are, the professional managers you hire via a mutual fund, for 1% of assets or more per year, won’t be able to stay ahead either.

In October, Ray Dalio, one of the most successful hedge fund managers in the world, told a conference audience that “going forward, most investors are not going to be able to produce alpha.” “Alpha” is finance jargon for outperforming the market after accounting for risk. In truth, the search for alpha has always been something of a snipe hunt; the word was first used in a 1967 article that showed that most mutual funds didn’t deliver it, especially after subtracting fees.

Two things have changed since then: More pros admit the alpha game is over, and perhaps more important for you, investing has never been better for those willing to stop playing. In the words of Tadas Viskanta, editor of the finance blog Abnormal Returns, there’s wisdom in reaching for “investment mediocrity.”

Today, just as in 1967, most professionals can’t beat an index that tracks the stock market. “The paradox,” says Viskanta, “is that the less effort you put in, the better off you are.” And recently, he notes, perfect mediocrity has grown more attainable, as index-based investing has moved steadily closer to free.

For as little as 0.04% of assets per year — that’s $4 for every $10,000 you’ve invested — and often with no broker commission, you can buy an exchange-traded fund, or ETF, that follows most of the U.S. stock market and delivers its return.

This year’s Investor’s Guide starts from the idea that index funds and a buy-and-hold stance should be the default approach for long-term wealth builders. With that in mind, MONEY has rebuilt our basic investing tool set: Our list of recommended funds is now the MONEY 50, streamlined from 70. Not all the funds are index trackers, but the core choices are low-cost, highly diversified portfolios for the long run. For many investors, a portfolio balanced among one broad U.S. stock fund, an international fund, and one or two bond funds is all you need. The MONEY 50 makes building that portfolio easy.

Yet even if you decide to stick with a simplified strategy, that doesn’t mean every investment puzzle you’ll face has been solved. The stories in this guide will help you think through your approach to the three biggest questions you still face as you save for retirement.

Question No. 1: Buy and hold what exactly?

You can build a simple portfolio for any level of risk. Stretching for high returns? You could put all your money in the Schwab U.S. Broad Market SCHWAB STRATEGIC T US BROAD MKT ETF SCHB 0% , or crank up risk and return potential further by adding funds like Vanguard Small-Cap VANGUARD INDEX FDS VANGUARD SMALL-CAP ETF VB -0.0825% or Vanguard FTSE Emerging Markets VANGUARD INTL EQUI FTSE EMERGING MARKETS VWO 0.2192% . Need safety? Stash more in Vanguard Total Bond Market VANGUARD BD IDX FD TOTAL BOND MARKET BND 0.0606% or iShares Barclays TIPS Bond ISHARES BARCLAYS TIPS BOND FUND TIP 0.1491% to add inflation protection.

These funds make security selection automatic, but they don’t help at all with the question of how much risk you want to take. The standard rule of thumb says you should start out with a high allocation to equities and gradually “glide” that down as you age. These days fund companies often focus less on their stock-picking prowess and more on designing all-in-one “target date” funds that do this asset allocating for you. Yet as you’ll see in “How much should you hold in stocks?,” the theory and practice of lifetime asset allocation are all over the map.

Question No. 2: What if high stock and bond returns are really over?

If you’re a just-own-the-market purist, you don’t ask if stocks are cheap or expensive. You assume it’s too hard to outwit the hive-mind intelligence of the crowd. Over the short run that’s almost certainly true. But there’s evidence that the price of stocks relative to measures of their value like earnings and assets can provide a clue about returns over the course of a decade.

Stocks are now priced at about 21 times the five-year average of their earnings. According to research from the Leuthold Group advisory firm, when the market’s price-to-earnings ratio is between 20 and 25, over the next 10 years stocks have delivered an annualized return of only 3% after accounting for inflation.

Combine that with a gloomy outlook for bonds. Current yields are an indicator of future returns, and with the 10-year Treasury at 2.8%, you may be lucky to carve out 1% after inflation. “Stocks, Bonds? In 2014, Think Cash,” will help you think through your strategy so that you can thrive in a world where today’s high-asset prices could repress tomorrow’s returns.

Question No. 3: Can I ever do better?

Maybe. Even some advocates of index investing say there may be ways to outperform. But the extra bump doesn’t come from tearing into company balance sheets or, as famed Fidelity manager Peter Lynch used to say, “buying what you know.” It comes from “tilting” a portfolio of hundreds of securities to take advantage of anomalies that have shown up in historical stock returns.

One is the value effect, the tendency of stocks with low prices relative to their earnings or asset value to outperform over time. Likewise, there seems to be a small-company premium. For a shot at earning these boosts, you don’t buy a portfolio of 40 or 50 small-caps or bargain stocks. Instead, you buy an index or index-like fund that gives more weight to such shares.

You’ll need nerve: Larry Swedroe of Buckingham Asset Management, who recommends tilting, says the strategy trailed the S&P 500 badly in the late 1990s; in the past decade, though, an index of small value stocks earned an extra 2% annualized. “You have to be able to live through it,” he says.

“The New Faces of Stock Picking” profiles a pioneer in low-cost, tilted portfolios as well as other quantitatively driven thinkers searching for ways investors can carve out advantages. Instead of hunting for the inside scoop, they crunch data and use insights into investors’ behavioral blind spots. A caution: Now that star fund managers have faded, Wall Street is cranking out lots of ETFs. For every robust new idea, there’s likely to be a dozen more that are nothing but savvy marketing tied to a hot short-term trend.

Investing may be simple now, but you’ll still need the discipline not to chase the latest market beater, plus the patience to stick to a long-term strategy even when it’s out of favor. Simple? Yes, but not always easy.

OWN THE WORLD, FOR NEXT TO NOTHING

You can build a solid portfolio with just three investments. Here are examples using ETFs and index mutual funds:

The ETF route:

Schwab U.S. Aggregate Bond SCHWAB STRATEGIC T US AGGREGATE BD ETF SCHZ 0.0962% : 40%
Schwab U.S. Broad Market: SCHWAB STRATEGIC T US BROAD MKT ETF SCHB 0% 40%
Schwab International Equity: SCHWAB STRATEGIC T INTL EQUITY ETF SCHF 0.2924% 20%

The index fund route:

Vanguard Total Stock Market Index: VANGUARD INDEX FDS TOTAL STK MARKET PORTFOLIO VTSMX 0.2797% 40%
Vanguard Total Bond Market Index: VANGUARD BD IDX FD TOTAL BOND MARKET BND 0.0606% 40%
Vanguard Tax Managed International VANGUARD TAX MANAG DEVELOPED MKTS INDEX FD INV VDVIX 0.1929% : 20%

Either way you go, your costs will be far, far less than most active fund managers charge…

Annual fee:

ETF portfolio: 0.05%
Index fund portfolio: 0.08%
Three average active funds: 1.22%

… and you’ll be diversified across the globe.

Number of stocks:

ETF portfolio: 3,144
Index fund portfolio: 4,823
Three average active funds: 289

SOURCE: Morningstar

MONEY health insurance

What’s Next for Retiree Health Care

Fewer companies are offering retiree health care benefits. Even if you get benefits from a former boss, you'll see some changes. Photo: Shutterstock

When it comes to getting health coverage from your old boss, the landscape is changing fast, and not just for early retirees.

Companies have been cutting back on retiree health benefits for years. Indeed, the latest survey by the Kaiser Family Foundation (KFF) found that among large firms with employee health coverage, just 28% offer some form of retiree benefits, down from 66% in 1988. Among smaller firms, help is even scarcer.

Disappearing corporate benefits is one reason the new public exchanges created by Obamacare will be such a boon to early retirees. But even for seniors who still get help from a former boss, change is afoot, no matter your age.

Here’s what to watch for:

Early retirees: If the public exchanges succeed, firms that offer pre-Medicare coverage may give those ex-workers funds to buy a policy on one, says Tricia Neuman, director of KFF’s Program on Medicare Policy. Employers are taking a wait-and-see approach, but that could change fast.

Retirees 65 and up: About a third of Medicare recipients have supplemental coverage from a former employer, says Neuman, and some of them are already seeing changes. Several major companies, recently IBM and Time Warner (MONEY’s parent company), are shifting retirees 65 and older from company-run plans to private exchanges operated by benefit consultants and insurance brokers.

On a private exchange, you’ll be able to pick supplemental Medicare coverage from a host of options, using funds your employer contributes to a tax-free health-reimbursement arrangement, or HRA.

For now, companies making this shift aren’t necessarily cutting back on how much they’re spending on your health care, says Paul Fronstin, a senior research associate at the Employee Benefit Research Institute (though IBM capped its contribution years ago). But how you’ll fare over time will depend on the employer subsidy keeping up with premium hikes, says John Grosso, health care actuary at Aon Hewitt. If not, you’ll pay more.

You or your parents may leap at the chance for more choices, or be overwhelmed by the sign-up process. It’s similar to open enrollment, but with potentially more options.

“Make use of all the tools out there,” says Sandy Ageloff, Southwest health and group benefits leader for Towers Watson, which owns Extend Health, the biggest private exchange. Tools include phone counseling at the exchange; the typical initial call runs about 80 minutes, Ageloff says.

MONEY

Planning To Retire Early? A Second Paycheck Comes In Handy

In the 1980s, Kevin Howard started buying houses, fixing them up, and renting them out. That rental income let him leave his job at 55. Sam Comen

No question, picking up a part-time gig after you walk away from 9-to-5 work will ease the pressure on your finances. And that’s the plan for many: Three-quarters of workers believe they will have a job in retirement, a May Gallup poll found.

It’s not just about the money. In a survey of 44- to 70-year-olds by the second-act job site Encore.org, a third of those who want to work part-time cited enjoyment as the reason.

But reality doesn’t match expectations. In EBRI’s 2013 Retirement Confidence Survey, only 25% of retirees report ever having worked for pay after calling it a career.

Would-be retirees are often unrealistic about landing meaningful part-time work, says Colorado planner Leitz. Lining up a 15- to 20-hour-a-week job sounds great, but there aren’t too many stimulating and well-paying jobs in professional fields that allow that. “Flexibility is great for you, but not really for employers,” says Leitz.

What to do

Go for projects, not a job. Even when firms don’t want a 20-hour-a-week senior staffer, they still may have high-level work that needs to get done. Set yourself up to be the consultant they hire, says Dick Dawson of CareerCurve, a coaching firm for 55-plus workers.

Start where you’re known: your old workplace and your network. Keep going to industry events and seek out contractors who do similar work and may hear of jobs they can’t take. Visit elance.com and peopleperhour.com, which match employers with freelancers in fields such as marketing, writing, and design.

Make your hobby pay. Working doesn’t have to mean sticking with the same career. Before retiring at 58, Susan Morgan Hoth was a high school teacher in Richmond who spent summers painting silk scarves. As she approached retirement, she started selling her scarves online through sites like Etsy.

Her business nets about $4,000 a year, enough to let Hoth, now 64, splurge more. “It helps me afford things I would not spend money on otherwise,” she says.

Similarly, you might find that a part-time retail job that matches your interests — in a golf shop, say, or a health-food store — is all you need to pad your income. Discounts on greens fees or organic granola are an added bonus.

Don’t get too comfortable. A lot can happen over 40 years, from a financial pinch to boredom. So even if you don’t work out of the gate, keep yourself employable. That means maintaining professional credentials, following changes in your industry, and staying in touch with former colleagues.

Think way ahead. Many early retirees plant the seeds for a second paycheck well before retirement. One way to do that is by investing in rental real estate. Hearts & Wallets found that 27% of those who successfully retired before 62 went that route.

Rental income is what made it possible for Kevin Howard, 57, to leave his full-time job as a procurement manager for Boeing two years ago. In the mid-1980s he began rehabbing and renting out houses. The properties — three in Seattle, where he lives, and one in his former hometown of Houston — provide half his annual $140,000 income (the rest is a pension and savings).

Still, “I don’t want to fix plumbing as I get older,” he says. He plans to sell his Houston house soon and the others within five years.

Now, instead of working on aerospace projects, Howard is learning to play the standing bass. He’s clocked 14,000 miles in 26 states on his motorcycle, and takes his VW Vanagon camper to blues festivals.

“I worked for 30 years,” Howard says. “I want another 30 years doing the things I want to do.”

MORE: New rules for early retirement

Rule 1: Early retirees: Don’t fear losing your health insurance

Rule 2: Getting ready to retire? Save more, spend less

Rule 3: Use your home to boost retirement savings

Rule 4: Get the first decade of retirement right

 

MONEY

Early Retirement: Why You Must Get The First Decade Right

How you allocate your portfolio and monitoring the market is crucial to maximizing your long-term income. Photo: Shutterstock

You should fear a bear.

The S&P 500 has turned in 16% average annual gains over the past three years, propelling the typical 401(k) balance to a record high this year, Fidelity reports. For workers 55 or older, it’s $255,000, nearly double what it was in March 2009, the depths of the bear market.

What stocks have in store now is crucial for early retirees, who might be inclined to count on continued high returns out of the gate. But stocks are looking expensive. Based on a conservative price/earnings ratio developed by Yale economist Robert Shiller, which uses 10 years of averaged profits, stocks are forecast to return 5% a year over the next decade. That could include down years as well.

Here’s why the market matters so much. Early on in retirement, you tend to spend more freely, as you can finally do all the things you were too busy to do when you worked: travel, eat out more, or indulge a costly hobby.

After you hit your mid-70s, your outlays start to drop, even when you take health care spending into account. People 65 to 74 spend 37% more than those 75 and older do, according to the Consumer Expenditure Survey. Retire young, and you’re starting those free-spending years early.

At the same time, crafting an income is trickier. Not only can’t you take Social Security until age 62, you’ll lock in a higher payment if you wait until full retirement age to claim (66 for a 60-year-old today; 67 for those born in 1960 or later). If you’re eligible for a pension and collect before 65, you’ll have to settle for as much as 30% less. So you’re especially dependent on your investments for income.

What to do

Hold out for a bigger check. As you navigate these bridge years, you’ll be better off if you can rely on your own resources first.

For every year you delay taking Social Security until age 70, you’ll collect an 8% bigger benefit. From then on, you can enjoy an annuity payment, in essence, that’s indexed to inflation. That’s worth waiting for.

Be willing to change. With bond yields low, a portfolio withdrawal rate that starts at 3% and adjusts for inflation is considered safer than the traditional 4% rule, says retirement researcher Wade Pfau. And that’s for 30 years, not the 35- or 40-year time horizon of an early retiree. For that, a safer rate dips to a measly 2.6%.

When you’re living entirely on withdrawals, 2% to 3% won’t cut it (unless you’ve saved a lot of dough). Simply boost your withdrawal rate, though, and you run a high risk of running out of money.

A 60-year-old couple earning $120,000 today a year and hoping to live on 70% of that, say, would have to withdraw 7% initially from a $1.2 million portfolio. But even if they cut back to 4% when full Social Security kicks in at 66, the chances of their money lasting until 90 drop below 50%.

To improve those prospects, get by on less. If the 60-year-old couple can live on 60% of their income, they can drop their withdrawal rates to 6% before claiming Social Security, then 3%, doubling their shot at success.

Crucially, if you allow yourself a higher withdrawal rate early on, you must cut back when Social Security kicks in. And since your spending patterns and market returns will undoubtedly vary, stay flexible. “This isn’t something you do once and forget about,” says planner Schroeder. “You need to review your income plan at least annually.”

Fear the bear. The other challenge is how to allocate your portfolio. In provocative new research, Pfau and Michael Kitces, director of research at Pinnacle Advisory Group, make the case for starting retirement with just 20% in stocks and gradually buying more over time. Do this, and chances are you’ll stretch out your savings a few more years and, more important, protect yourself from crippling anxiety and steep losses at the outset.

If a bear strikes early, you preserve capital and buy stocks on the upswing. If you retire into a bull market, you will miss out on some gains. But your overall odds are still better. “Heads you win, tails you won’t lose,” says Kitces.

Shifting money into stocks as you age may be too counterintuitive for you to pull off. A 50% or 60% stock stake that you gradually trim is also a good approach, says Vanguard investment research analyst Colleen Jaconetti. “In 2008, if you had been 50-50, you’d be ahead of where you are now,” she adds.

You’re walking a fine line. It’s hard to make your money last without the higher returns stocks can provide. But you need to preserve what you have. A bull market later won’t make up for early losses, says Jaconetti.

MONEY Retirement

Use Your Home to Boost Retirement Savings

Do you dream of leaving full-time work behind at 60, or even sooner? In MONEY’s 2014 Retirement Guide, you’ll learn the five essential rules for pulling off early retirement — rules built on tough lessons from recent years and new thinking about investing.

Rule 3: Be grateful, not greedy, about your gains

The housing market’s recent recovery may be one of the things that’s giving you the confidence — and the wherewithal — to retire ahead of schedule. Home prices in 20 major metro areas are up 12% over the past year, the biggest gain since 2006, according to the widely followed S&P/Case-Shiller home price index.

In seven of those markets, values are higher than or nearing their pre-crash peak, says David Blitzer, managing director at S&P Dow Jones Indices. American homeowners have seen their equity rise more than $2 trillion in just the past year, according to the Federal Reserve.

Alas, you can’t count on a housing boom to keep padding your net worth. With rising mortgage rates and tepid economic growth, the pace of price gains is expected to slow. “A year from now home prices will be higher, but half the double-digit gains we’ve seen,” says Blitzer.

You need to set realistic expectations for what your home can do for you, and plan prudently with what you have. That might mean leaving your old digs behind.

What to do

Lose two bedrooms. Moving out of your home of decades can pay off in two ways. By selling into a strong market now and buying a smaller house, you can lock in your good fortune, letting you add to your savings or wipe out any lingering debts.

Related: How much house can you afford?

Plus, if retiring early means learning to live on less, there’s no better way to do that than to cut your housing costs, which typically eat up 40% of retirees’ budgets, according to the Consumer Expenditure Survey.

Get out of town. Only 10% of retirees pick up stakes, though boomers look to be a bit more likely to relocate than previous generations were. In a 2012 AARP survey, two in 10 boomers said they planned to move in retirement.

“Boomers are different,” says Fred Brock, author of Retire on Less Than You Think. “They are willing to move to cheaper parts of the country.” With families more mobile, he adds, you don’t need to be tied to one place to stay near your kids.

Join this minority and move to a town with lower property taxes and lower living costs, as well as cheaper homes, and you can leverage your profits even more. That’s what Sheri and Bill Pyle did when they sold their three-bedroom Cape Cod outside Chicago for $185,000, paid cash for a $128,000 four-bedroom ranch in Tennessee, retired a home equity line and car loan, and added $30,000 to their savings.

And though their income is less than 40% of the $126,000 they used to earn, their cost of living is so low that they are able to get by on their combined Social Security, leaving their $400,000 in retirement savings to grow for now.

Their property taxes plummeted from $7,000 to $500 a year. Milder winters mean their heating bills are a third of what they used to pay. “We could never have done it if we stayed in Chicago,” says Sheri.

Beware the trap of leisure fees. Whether you downsize locally or across the country, it’s crucial that you don’t simply trade maintenance costs for steep association fees.

“I see a lot of people who move into a new home for retirement, and their cost of living goes up, not down,” says Colorado Springs financial planner Linda Leitz, national chair of the National Association of Personal Financial Advisors.

When Gundy and Karen Gunderson retired in 2007, the Seattle couple bought a home in a gated country-club community in Las Vegas. But they were surprised at how quickly the costs added up. Gundy, 66, a former commercial airline pilot, and Karen, 67, a homemaker, estimate they were spending $1,000 a month on dues for the private golf course, tennis and fitness classes, the club’s restaurant minimum, and maintenance on their pool and lawn.

Related: 10 Best Places to Retire

“We ran the numbers and knew we had to make an adjustment if we wanted our money to last,” says Gundy. So this year they downsized a second time, to a Henderson, Nev., retirement community overlooking two public golf courses. Now all they pay is a $93 monthly association fee.

Invest in staying put. All this said, what if you really don’t want to leave your home? At a minimum, early retirees told us they avoided carrying a mortgage into retirement, as 30% of retirees do.

While you’re still working, invest in improvements that will cut costs later, like replacing old appliances and drafty windows and upgrading your heat and electrical systems. “If you’ve been in your home a long time, there’s a lot you can do to make it less costly,” says Stillwater, Okla., financial planner Louise Schroeder.

MORE: New rules for early retirement

Rule 1: Early retirees: Don’t fear losing your health insurance

Rule 2: Getting ready to retire? Save more, spend less

Rule 4: Get the first decade of retirement right

Rule 5: Retiring? Time to look for a part-time gig

MONEY

Getting Ready to Retire? Save More, Spend Less

Do you dream of leaving full-time work behind at 60, or even sooner? In MONEY’s 2014 Retirement Guide, you’ll learn the five essential rules for pulling off early retirement — rules built on tough lessons from recent years and new thinking about investing.

Rule 2: Early retirement means tradeoffs, now and later

Funding your retirement, never a breeze, has become tougher in this economy. Interest rates are hovering near historic lows, and bond guru Bill Gross recently warned that low rates may persist for decades. So what you can earn on low-risk cash and bonds will remain paltry.

Wade Pfau, a researcher and professor at the American College of Financial Services, has calculated sure-fire retirement savings rates in this rate environment.

If you hope to retire at age 65 and start saving at 35 — when baby boomers typically began, a May 2013 Bank of America Merrill Edge survey found — it’s 15% to 19% a year. Move your retirement date up by five years, and those rates go to 23% to 29%, Pfau says.

You probably can’t hit those daunting targets year in, year out. So the trick is to gain ground when you can — and be willing to make the math work by living on less.

What to do

Buckle down. You can catch up with bursts of savings — often easier once big expenses like college or a mortgage fall away.

According to retirement research firm Hearts & Wallets, saving 15% or more of your income for eight to 10 years — early or late in your career — can ensure that you save enough to retire comfortably at 65. Such power saving is common among early retirees too, says Hearts & Wallets co-founder Laura Varas, but the rate is 25% or more.

Related: 10 Best Places to Retire

Calvin Lawrence was able to retire from his job as executive director at Corinthian College in Chesapeake, Va., four years ago at 59, even though he hadn’t gotten serious about retirement planning until after he divorced at 50.

At that point he had about $200,000 set aside. With his two children out of college (and out of the house), tuition and other child-care bills were gone. And a promotion had boosted his pay by $20,000.

Even though he made $110,000 a year, “I lived like I earned $50,000,” says Lawrence, now 63. “I found that I don’t need to spend a whole lot of money to be happy.” The result: He built his savings to $800,000.

Put windfalls to work. Whether it’s an inheritance or a bonus, a windfall can make the difference between leaving early and working until 65.

When Bill Balderaz, now 39, sold the social media marketing business he founded in 2011, he and his wife, Christina, an elementary-school teacher, put themselves on the road to retirement in their fifties. With profits of a few hundred thousand dollars, the couple wiped out the big expenses that often make saving for the future hard — paying off the mortgage on their home in Upper Arlington, Ohio, and setting aside public school college tuition for their kids. The rest went toward retirement funds, which now total $600,000.

Related: Will you have enough to retire?

Just as critically, they didn’t ratchet up their spending. “We didn’t buy a Mercedes or build a new house or send our kids to private schools,” says Bill, now president of Fathom Columbus, the online marketing firm that bought him out.

He still drives a 17-year-old Toyota Tacoma pickup truck. In the market for a boat for the family — the children range from 10 months to 11 years — he bought a decade-old 18-footer off Craigslist for $9,000. A similar new one would have cost $27,000. “We live like the acquisition didn’t happen,” Bill says.

Set low expectations. To get away with saving less, commit to living on less. Planners typically suggest you aim to replace 70% to 80% of your pre-retirement income, which doesn’t amount to a dramatic lifestyle change once you eliminate the money you were saving, Social Security taxes, and commuting costs.

If you can make it on 50%, you need to save 11.8 times your income by age 60, vs. 17 times if you hope to live on 70%, says Charles Farrell, CEO of Northstar Investment Advisors.

As you’ll see in rule No. 3, housing could be the key to doing this. Plus, “people who want to retire early are usually already living well below their means,” notes Farrell. “This might not be a big change.”

MORE: New rules for early retirement

Rule 1: Early retirees: Don’t fear losing your health insurance

Rule 3: Use your home to boost retirement savings

Rule 4: Get the first decade of retirement right

Rule 5: Retiring? Time to look for a part-time gig

MONEY

The Secret Weapon To Early Retirement: Your Home

2013 Getty Images

The housing market’s recent recovery may be one of the things that’s giving you the confidence — and the wherewithal — to retire ahead of schedule. Home prices in 20 major metro areas are up 12% over the past year, the biggest gain since 2006, according to the widely followed S&P/Case-Shiller home price index.

In seven of those markets, values are higher than or nearing their pre-crash peak, says David Blitzer, managing director at S&P Dow Jones Indices. American homeowners have seen their equity rise more than $2 trillion in just the past year, according to the Federal Reserve.

Alas, you can’t count on a housing boom to keep padding your net worth. With rising mortgage rates and tepid economic growth, the pace of price gains is expected to slow. “A year from now home prices will be higher, but half the double-digit gains we’ve seen,” says Blitzer.

You need to set realistic expectations for what your home can do for you, and plan prudently with what you have. That might mean leaving your old digs behind.

What to do

Lose two bedrooms. Moving out of your home of decades can pay off in two ways. By selling into a strong market now and buying a smaller house, you can lock in your good fortune, letting you add to your savings or wipe out any lingering debts.

Related: How much house can you afford?

Plus, if retiring early means learning to live on less, there’s no better way to do that than to cut your housing costs, which typically eat up 40% of retirees’ budgets, according to the Consumer Expenditure Survey.

Get out of town. Only 10% of retirees pick up stakes, though boomers look to be a bit more likely to relocate than previous generations were. In a 2012 AARP survey, two in 10 boomers said they planned to move in retirement.

“Boomers are different,” says Fred Brock, author of Retire on Less Than You Think. “They are willing to move to cheaper parts of the country.” With families more mobile, he adds, you don’t need to be tied to one place to stay near your kids.

Join this minority and move to a town with lower property taxes and lower living costs, as well as cheaper homes, and you can leverage your profits even more. That’s what Sheri and Bill Pyle did when they sold their three-bedroom Cape Cod outside Chicago for $185,000, paid cash for a $128,000 four-bedroom ranch in Tennessee, retired a home equity line and car loan, and added $30,000 to their savings.

And though their income is less than 40% of the $126,000 they used to earn, their cost of living is so low that they are able to get by on their combined Social Security, leaving their $400,000 in retirement savings to grow for now.

Their property taxes plummeted from $7,000 to $500 a year. Milder winters mean their heating bills are a third of what they used to pay. “We could never have done it if we stayed in Chicago,” says Sheri.

Beware the trap of leisure fees. Whether you downsize locally or across the country, it’s crucial that you don’t simply trade maintenance costs for steep association fees.

“I see a lot of people who move into a new home for retirement, and their cost of living goes up, not down,” says Colorado Springs financial planner Linda Leitz, national chair of the National Association of Personal Financial Advisors.

When Gundy and Karen Gunderson retired in 2007, the Seattle couple bought a home in a gated country-club community in Las Vegas. But they were surprised at how quickly the costs added up. Gundy, 66, a former commercial airline pilot, and Karen, 67, a homemaker, estimate they were spending $1,000 a month on dues for the private golf course, tennis and fitness classes, the club’s restaurant minimum, and maintenance on their pool and lawn.

“We ran the numbers and knew we had to make an adjustment if we wanted our money to last,” says Gundy. So this year they downsized a second time, to a Henderson, Nev., retirement community overlooking two public golf courses. Now all they pay is a $93 monthly association fee.

Invest in staying put. All this said, what if you really don’t want to leave your home? At a minimum, early retirees told us they avoided carrying a mortgage into retirement, as 30% of retirees do.

While you’re still working, invest in improvements that will cut costs later, like replacing old appliances and drafty windows and upgrading your heat and electrical systems. “If you’ve been in your home a long time, there’s a lot you can do to make it less costly,” says Stillwater, Okla., financial planner Louise Schroeder.

MONEY

Dreaming Of Early Retirement? Three Secrets To Making It Work

Bill and Christina Balderaz, 39 and 37, Upper Arlington, Ohio. The couple got a windfall when Bill's company was sold. But in hopes of retiring before 60, they continue to spend as carefully as before. Sam Comen

Funding your retirement, never a breeze, has become tougher in this economy. Interest rates are hovering near historic lows, and bond guru Bill Gross recently warned that low rates may persist for decades. So what you can earn on low-risk cash and bonds will remain paltry.

Wade Pfau, a researcher and professor at the American College of Financial Services, has calculated sure-fire retirement savings rates in this rate environment.

If you hope to retire at age 65 and start saving at 35 — when baby boomers typically began, a May 2013 Bank of America Merrill Edge survey found — it’s 15% to 19% a year. Move your retirement date up by five years, and those rates go to 23% to 29%, Pfau says.

You probably can’t hit those daunting targets year in, year out. So the trick is to gain ground when you can — and be willing to make the math work by living on less.

What to do

Buckle down. You can catch up with bursts of savings — often easier once big expenses like college or a mortgage fall away.

According to retirement research firm Hearts & Wallets, saving 15% or more of your income for eight to 10 years — early or late in your career — can ensure that you save enough to retire comfortably at 65. Such power saving is common among early retirees too, says Hearts & Wallets co-founder Laura Varas, but the rate is 25% or more.

Related: 10 Best Places to Retire

Calvin Lawrence was able to retire from his job as executive director at Corinthian College in Chesapeake, Va., four years ago at 59, even though he hadn’t gotten serious about retirement planning until after he divorced at 50.

At that point he had about $200,000 set aside. With his two children out of college (and out of the house), tuition and other child-care bills were gone. And a promotion had boosted his pay by $20,000.

Even though he made $110,000 a year, “I lived like I earned $50,000,” says Lawrence, now 63. “I found that I don’t need to spend a whole lot of money to be happy.” The result: He built his savings to $800,000.

Put windfalls to work. Whether it’s an inheritance or a bonus, a windfall can make the difference between leaving early and working until 65.

When Bill Balderaz, now 39, sold the social media marketing business he founded in 2011, he and his wife, Christina, an elementary-school teacher, put themselves on the road to retirement in their fifties. With profits of a few hundred thousand dollars, the couple wiped out the big expenses that often make saving for the future hard — paying off the mortgage on their home in Upper Arlington, Ohio, and setting aside public school college tuition for their kids. The rest went toward retirement funds, which now total $600,000.

Related: Will you have enough to retire?

Just as critically, they didn’t ratchet up their spending. “We didn’t buy a Mercedes or build a new house or send our kids to private schools,” says Bill, now president of Fathom Columbus, the online marketing firm that bought him out.

He still drives a 17-year-old Toyota Tacoma pickup truck. In the market for a boat for the family — the children range from 10 months to 11 years — he bought a decade-old 18-footer off Craigslist for $9,000. A similar new one would have cost $27,000. “We live like the acquisition didn’t happen,” Bill says.

Set low expectations. To get away with saving less, commit to living on less. Planners typically suggest you aim to replace 70% to 80% of your pre-retirement income, which doesn’t amount to a dramatic lifestyle change once you eliminate the money you were saving, Social Security taxes, and commuting costs.

If you can make it on 50%, you need to save 11.8 times your income by age 60, vs. 17 times if you hope to live on 70%, says Charles Farrell, CEO of Northstar Investment Advisors.

As you’ll see in rule No. 3, housing could be the key to doing this. Plus, “people who want to retire early are usually already living well below their means,” notes Farrell. “This might not be a big change.”

MORE: New rules for early retirement

Rule 1: Early retirees: Don’t fear losing your health insurance

Rule 3: Use your home to boost retirement savings

Rule 4: Get the first decade of retirement right

Rule 5: Retiring? Time to look for a part-time gig

MONEY

Early retirees: Don’t fear losing your health insurance

Health insurance has long been one of the biggest obstacles to early retirement. Few employers offer coverage — just 18% of current private-sector workers are eligible for pre-65 retiree benefits, vs. 29% in 1997, according to EBRI.

And buying a policy on the private market before you qualify for Medicare at 65 has been a challenge: A condition like diabetes or heart disease can leave you uninsurable, while even healthy 50- and 60-year-olds pay far more than young people for the same coverage.

A recent Center for Retirement Research study found that the spike in retirement at 65 is due in large part to Medicare eligibility.

Under health reform, all that is poised to change. Regardless of your health, you can buy a comprehensive insurance policy through the state online exchanges that went live Oct. 1. Your age will still push up your premium, but a 60-year-old can’t be charged more than three times what a 20-year-old pays, down from today’s typical 5-to-1 ratio.

“Early retirees will be the biggest beneficiaries of the exchanges,” says Caroline Pearson, vice president at the consulting group Avalere Health.

What to do

Put a price tag on it. Obamacare means you can’t be turned down or charged more for health reasons, but it doesn’t necessarily mean a policy will be cheap. In the 36 states where the federal government is operating exchanges, monthly premiums for mid-level plans are averaging $432 for a 55-year-old and $526 for a 60-year-old, says Carrie McLean, head of customer care at eHealthInsurance.com; rates for a 55- to 64-year-old on the private market today average $329.

But that price difference reflects more robust coverage. A bare-bones policy you could buy this year might carry a $10,000 deductible or omit prescription-drug coverage — required for policies sold on the exchanges. Your combined deductible and out-of-pocket costs will also be capped, at $6,350 for an individual and $12,700 for a family.

“The insurance market is pretty scary for early retirees right now,” says Karen Pollitz, a senior fellow at the Kaiser Family Foundation. “It won’t be so scary anymore.”

Start at healthcare.gov to find options in your state. Heavy traffic and tech glitches made applying a headache right after enrollment opened, but you have until Dec. 15 to sign up for coverage starting on Jan. 1.

Check for price cuts. The premium is just the sticker price. About half of those who buy insurance on their own today will qualify for a subsidy, estimates Kaiser. And since that help is based on how much of your income must go toward insurance, an early retiree with a high premium has a good chance of qualifying for a break, especially if retirement means living on less.

A 60-year-old couple making $62,000, for example, would qualify for a subsidy that would bring a $1,140 monthly payment down to $491, according to the Kaiser Family Foundation subsidy calculator (available at kff.org). For a single person, the annual income cutoff to qualify for a subsidy is $45,000; for a family of four, it’s $94,000.

All that is good news for 62-year-old Sheri Pyle, who retired to Henry, Tenn., last year with her husband, Bill, 18 months after he left his job at a family-owned heating and plumbing firm at 62. Weary of Chicago winters and 60-hour workweeks, the couple dreamed of spending their days in warmer climes, camping, fishing, and volunteering. They now pitch in at the county search and rescue.

“We wanted to quit working while we’re still young enough to enjoy our lives and give back,” says Sheri, who managed the accounting department for a food manufacturer. Bill, now 65, qualifies for Medicare. But Sheri, who has arthritis, has been worried about her insurance costs once her former employer’s $400-a-month COBRA coverage ends in December. On the Tennessee exchange her monthly premium would run $593 for a midlevel plan. But she’ll qualify for a subsidy that will knock it down to $345.

 

MONEY real estate

Best Places to Retire

Love the culture and excitement of urban life, but loathe the congestion and cost? One of these ‘second cities’ could be your first-choice retirement spot.

If the thought of retiring to a sleepy beach town or country hamlet bores you silly, you’re not alone. Increasingly, retirees are “interested in urban center communities,” says John McIlwain, senior fellow at the Urban Land Institute. “They don’t want to be isolated out in the suburbs.” It’s not surprising that people want to spend their post-work years surrounded by the arts, cutting-edge health care, and diverse neighbors, but the cons of urban living (like cost) can be daunting. So we set out to find places that won’t ding your nest egg with high taxes and nosebleed prices, yet still have great attractions and plenty of your peers. Here are five affordable small cities you may one day want to call home.

  • Raleigh, N.C.

    This state capital’s thriving economy and proximity to top universities have long made it a prime relocation destination. And recently more of those new faces have had a few wrinkles: From 2000 to 2010 the city’s population of 55- to 64-year-olds shot up by 97%, according to the Brookings Institution.

    It’s not hard to see the draw: Raleigh provides a big-city feel with a low cost of living; mild, four-season weather; and, thanks to all those medical schools, world-class health care.

    Where to live

    Midtown/North Hills: Retirees looking for a good deal and a practical location should shop north of downtown, says local real estate agent Kim Crump. There you’ll find spacious townhouses starting at around $200,000.

    Downtown: Those willing to pay about twice that price may consider the new condos and lofts downtown. “It’s stimulating to be around a young and diverse population,” says Jim Belt, now 62, who retired from finance in 2006 and along with his wife, Donna, moved from London to downtown Raleigh.

    The couple say living in the center of things made it easy to get involved. Jim founded a downtown residents group. Donna, 59, started BEST Raleigh, a group that puts art in vacant storefronts.

    What to do

    Food: The city has a diverse restaurant scene, with everything from Afghan cuisine to Southern barbecue.

    Music:
    The 5,000-seat Red Hat Amphitheater hosts the big acts, while the opera and symphony perform at the Duke Energy Center for the Performing Arts.

    Art:
    A range of work is on display in galleries, public spaces, and parks. Or take in the 30 Rodin sculptures at the North Carolina Museum of Art.

    Education: North Carolina State University’s lifelong-learning program offers affordable courses and study trips on topics including garden ecology and classical music.

    Taxes

    Like most of the states in this gallery, North Carolina does not tax Social Security benefits. The state has no inheritance or estate tax.

    Income tax:

    • 5.8% flat (starting 2014)
    • Sales tax: 6.75%
    • Median property tax: $1,800

     

  • Pittsburgh

    Talk about a comeback. At the turn of the 20th century Pittsburgh was an economic and cultural hub, home to Andrew Carnegie and other captains of industry. Then came deindustrialization and job losses in the 1980s. Now the city is polishing its rusty image by converting old mills and factories into office space, galleries, and lofts.

    The once-dwindling population is also bouncing back; the city took the top spot in U-Haul’s 2012 relocation survey, with a 9% jump in transplants. For retirees, Pittsburgh offers a true urban experience, including good public transportation, pro sports, and a host of top universities, all at a bargain price.

    Where to live

    The Northeast and South: Jim and Deborah Bogen moved to Pittsburgh from California in 2000, when Jim, now 78, retired from the philosophy department at Pitzer College.

    During a teaching stint at the University of Pittsburgh, he fell in love with the town, its 90 eclectic neighborhoods, and the green, hilly landscape. For Deborah, the move to a more affordable city had major practical implications. “If we hadn’t come here, I’d still be working,” says Deborah, 63, who retired from her paralegal job at age 50 and now writes poetry and novels.

    Homes in popular neighborhoods like Highland Park (where the Bogens live) or the South Side are now fetching more than $300,000 or so, double what the Bogens paid. Still, many remain a bargain by other big-city standards. Plus, the area is easy to navigate on foot, providing an extra perk: “I lost 20 pounds the first year we lived here,” says Deborah.

    What to do

    Museums: The four Carnegie Museums span art, science, natural history, and a collective 1.3 million square feet. The Andy Warhol Museum is a local favorite (the artist grew up here).
    Performance: Renovated concert halls are home to a thriving symphony, ballet, and opera.
    Sports: Thanks to the Steelers, Penguins, and Pirates (who recently made the playoffs for the first time since 1992!), superfans can stay busy all year.
    Outdoors: There are five large city parks, including the 561-acre Frick Park, where you can try lawn bowling or tennis.

    Taxes

    Distributions from most retirement plans, including qualifying 401(k)s and IRAs, are largely exempt. There is an inheritance tax, but there is no estate tax.

    • Income tax: 3.07% flat
    • Sales tax: 7%
    • Median property tax: $2,450
  • Lexington, Ky.

    Retirees looking to mix city activities with country charm will find a lot to love here. Lexington’s historic downtown is packed with galleries, restaurants, and boutiques. But drive just a few minutes and you’re in the rolling hills of Bluegrass Country.

    The city is also home to one of the country’s oldest and most robust lifelong-learning programs, as well as the top-scoring University of Kentucky Albert B. Chandler Hospital, which has received accolades from the American Heart Association and National Cancer Institute.

    Where to live

    Downtown: Over the past decade, a crop of new condos and loft conversions has transformed the center of Lexington. Indeed, developers got a little overzealous during the boom years, says realtor Casey Weesner, so prices stagnated and condos sat empty in the wake of the housing crash.

    The market has picked up in the past year, he says, but there are still some downtown bargains to be had. Expect to see modern two-bedroom condos priced around $200,000.

    What to do

    Sports: Welcome to basketball heaven. The Wildcats, the University of Kentucky’s powerhouse team, play at Rupp Arena, which also hosts shows and big music acts.
    Education: Locals age 65 and older can sit in on university classes, sans tuition, whenever there are open seats. The school’s Osher Lifelong Learning Institute offers classes for the 50-plus set.
    Arts: The campus also boasts the Singletary Center for the Arts. Downtown, the Kentucky Theatre shows independent and classic films.
    Outdoors: Churchill Downs, home of the Kentucky Derby, is 90 minutes away. Bikers can hop on the 12-mile Legacy Trail, which leads to the equine events at Kentucky Horse Park.

    Taxes

    Up to $41,110 per person in retirement income is exempt. Homeowners 65 or older get a property tax break. Some family members are exempt from the inheritance tax.

    • Income tax: Top rate is 6%
    • Sales tax: 6%
    • Median property tax: $1,620
  • St. Petersburg, Fla.

    Can’t imagine retirement without a beach? In St. Pete you can dip your toes in the Gulf of Mexico or Tampa Bay — plus play a round of golf, eat virtually any type of cuisine, and see famous art, all in a single day.

    While St. Petersburg is undoubtedly a retiree hotspot, the city has also drawn more young families in recent years, says local realtor Judy Horvath. The mix helps keep the city vibrant and stocked with boutiques, galleries, and restaurants.

    Where to live

    Downtown: The market for new apartments and condos was flattened by the bust, but developments are now back on track and in many cases selling out quickly. New two-bedrooms downtown start at around $300,000, says St. Petersburg agent Rachel Sartain.
    Surrounding neighborhoods: If that’s too expensive, going five or 10 minutes outside of downtown brings prices down dramatically; condos in many central areas start in the $200,000 range, says Sartain.

    What to do

    Beaches: Two of the nation’s best (according to TripAdvisor readers) are just a 10-mile drive from downtown, including North Beach, located in the 1,140-acre Fort De Soto Park.
    Art: Try the Dalí Museum for works by the Spanish surrealist, or the Museum of Fine Arts for Monet and O’Keeffe
    .
    Sports:
    Tropicana Field is home to the Tampa Bay Rays. There are also plenty of golf courses, including Mangrove Bay, a par-72 championship course. At $25 a round, these municipal greens may be the city’s best bargain.

    Taxes

    Retirement income is not taxed. Permanent residents get a property tax exemption of up to $50,000.

    • Income tax: None
    • Sales tax: 7%
    • Median property tax: $1,080
  • Boise, Idaho

    © imagebroker / Alamy

    Moving to a mountain town means easy access to skiing, hiking, golf, fly-fishing, and more. Unfortunately, it also usually means jaw-dropping home prices, a dinky airport, limited health care, and tourists galore. Not in Boise.

    Yes, locals here can ski at Bogus Basin 16 miles from downtown, stroll or bike 85 miles of trails, and paddle or fish on the Boise River, which runs through town. But they’ll also find low taxes and affordable homes.

    Plus, Boise has become a nucleus of culture and health care. Saint Alphonsus Regional Medical Center is ranked in the top 5% of hospitals nationwide for clinical performance.

    Where to live

    North and East of downtown: Prices in the city center are steep, so buyers should concentrate on the surrounding neighborhoods, says Boise real estate broker Jason G. Smith. “Traffic isn’t an issue,” he says. “So you don’t need to be right downtown to enjoy it.”

    You’ll find two-bedroom condos or small single-family houses priced at about $300,000 in the North End.
    Southeast and Northwest Boise: On a tighter budget? Head to these neighborhoods (located about 10 minutes from the city center) for homes starting around $200,000.

    What to do

    Outdoors: Walk along the Boise River Greenbelt or explore the trails winding out of Hull’s Gulch or Camel’s Back Park. The city has two open-air Saturday markets, which are a great place to find produce and bump into friends.
    Art: The Boise Art Museum has 3,000 permanent works and presents diverse exhibitions ranging from site-specific installations to collections of ancient artifacts.
    Performance: Grab tickets for the opera, philharmonic, or ballet. Boise State’s Morrison Center hosts national tours of Broadway shows, stand-up comedy, and live music, while the Shakespeare Festival fills a 770-seat outdoor amphitheater.

    And there’s more to come: Construction is under way for a new $70 million, 65,000-square-foot cultural center, slated to open in 2015.

    Taxes

    Retirement benefits are taxed, though some types of pensions qualify for a deduction. There is no inheritance or estate tax.

    • Income tax: Highest is 7.4%
    • Sales tax: 6%
    • Median property tax: $1,230
  • Spokane, Wash.

    © Andre Jenny / Alamy

    Unlike gloomy Seattle, Spokane basks in about 260 days of sunshine a year. Want to get out and soak up that vitamin D? The Spokane area has 76 lakes and five ski resorts, plus plenty of golf courses and wineries.

    The city has urban appeal too, with a downtown that’s become a destination for retirees looking to trade high maintenance homes for condos that are walking distance from restaurants, art galleries, and theaters.

    Spokane residents do pay a hefty 8.7% sales tax, but the state has no income tax.

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