Welcome to the forum; let me see how I can help you with a few things.
Here goes--I have been trying to understand MR. Mustache's method of investing, and as I understand it, he withdraws 4% from his investment.
I don't think he withdraws anywhere near a full 4%. The purpose of mentioning that number is that 4% has generally been - and is believed to be, going forward - a sustainable withdrawal rate from a
reasonable, balanced portfolio. That is, it is expected that if you have 25x your expected annual expenses in appropriate investments, you'll be able to withdraw enough to live off of, indefinitely. That is, you are no longer dependent on a paycheck for your living expenses.
(obviously, your "expenses" here have to account for taxes in some form or another, unless everything is in a Roth IRA and accessible within that; this is a slightly simplified version, but sufficient for planning, at least at the moment)
The 4% rule isn't his, by the way. It comes from studies long before him about how long a portfolio can sustain someone, among other things. The important takeaway, though, is that if you have a reasonably allocated portfolio, you can withdraw 4%/year indefinitely in most circumstances (the one worry that kills the 4% - sometimes, not even always - is runaway inflation, something I don't think we have to worry about in the U.S.).
This made me wonder...he couldn't have withdrawn this 4% from his 401K so it had to be mutual funds.
I think you're misunderstanding what these are.
A 401(k) is an investment
account - just like an IRA is, or a 403(b), or a standard brokerage account. A 401(k) has its own set of tax rules (it's actually called a 401(k) because that's the section of the tax code it comes from) and restrictions.
A mutual fund is a type of investment. You can (and almost certainly do) have mutual funds in your 401(k). I did, back when I had them. I still do in my IRAs and taxable investment account. There are many varieties of mutual funds. As a general statement, once you know which
assets you wish to hold, a low-cost, low-turnover mutual fund is a great way to buy these. The index variety are particularly popular, and, I believe, with good reason. They are my preferred method of investment.
It's also worth noting: while MMM has clearly done quite well for himself, I don't think he started off investing with the goal of early retirement (not sure if that's your goal or not from your post). He lived (and continues to live) a lifestyle with little waste (biking instead of driving when he can, cooking instead of eating out every day, not having every cable channel on a huge TV, etc); this, coupled with a high income, caused him to have a high savings rate - which, naturally, he invested in a variety of ways. One day, he realized his passive income was higher than his annual expenses - he literally didn't need the paycheck anymore, and eventually decided to do other things with his life that he found more meaningful and fulfilling (some of which bring in money, which doesn't hurt; some of which don't).
Incidentally, this side income is one reason he doesn't withdraw the full 4% each year. Another is that his investments have grown to such a point that 4% is far more than his annual expenses.
My question is, should I continue to invest 16% of my income into my 401K (with Fidelity) or should I break this up to include a Mutual Fund--where I would be able to withdraw income just as the MMM dude is doing?
I have no idea what your 16% figure is. I have friends who
can't invest 16% of their paycheck in a 401(k) due to limits in the tax code. In general, I think you should contribute to your 401(k) as much as possible, at least until you have "enough" in there (see below for link with explanation of that).
If your goal is to retire
after or in the year in which you will turn 59.5, you can keep contributing to your 401(k) well after you have enough. Otherwise, you have to start some planning.
Should you use the mutual funds in your 401(k)? Probably; I've yet to hear of better options within a 401(k). I've certainly heard of worse.
In general, your investments for retirement are generally advised to be as follows:
* Contribute enough to your 401(k) to get the company's match. There are very few situations where you don't want to do this.
* Pay off any toxic debt, such as credit cards. Reasonable people disagree here as to whether or not low-effective-interest debt (such as many mortgages and some student loans) should be repaid before continuing.
* After you have contributed enough to get the match, you probably want to max out a Roth IRA. You wouldn't do this if you weren't eligible (and also couldn't do a backdoor Roth), or if your 401(k) options were better than what you could get in an IRA (rare), or if your income is sufficiently low that you still qualify for a traditional IRA, and the tax deduction from this is worth it for you. In 2013, you can contribute the maximum of $5500 or your earned income for the year to an IRA; this is across both IRA types (does not include rollovers) and investment companies (you can't put $5500 in one at Fidelity and another $5500 in at Vanguard).
If you earn more than $112,000 (I don't think you do, if you are contributing 16% of your paycheck to your 401(k)), you can't contribute the full amount to a Roth IRA this year. If you're over 50, you can add another $1000 to what you can contribute.
* After you have done this, increase 401(k) contributions until you hit the maximum; if you're under 50, this is $17,500 for 2013; I think it's $5500 higher for 50+. Once you have
enough in your 401(k), consider reducing this step (depending on income and desired retirement age).
* After that, consider taxable investments. Be aware of tax-efficient investing, and be sufficiently informed to decide if your taxable portfolio is to be treated as part of your overall portfolio, or if you treat them differently. Reasonable people disagree on what is right here, regardless of desired retirement age.
FWIW: I have $150K in 401K and about $20k in savings. If there is more information needed, please let me know.
* How old are you?
* What do you expect your expenses to be like in retirement?
* Do you have any other retirement savings (e.g., old 401(k)s, an IRA or two, taxable investments)?
* Are you saving for anything else (next car, a house, other long-term savings goal)?
* What is the money in your 401(k) invested in (which funds; name, ticker, and expense ratio)?
* Which other choices are available to you in the 401(k)?
