And is it directly proportional to the cost of living in any given area?
We’ve done this a bunch, usually in connection with hoped-for lottery winnings.
If you want to live off the interest over the long term, you need to make enough interest each year to first, pay taxes on that interest; second, offset inflation which is always reducing the value of your principal; and third, provide enough additional interest to live on.
Different people will assume different interest rates, but I look at it about like this: I can usually get Treasury bonds/bills at about 5%. The importance of investing is something safe oughta be pretty obvious to everyone these days.
Of that 5% interest I receive, I’m going to lose about 1/4th of it to taxes, maybe a little more. So that reduces the 5% yield to, say, 3% for round numbers.
Inflation runs a couple percent a year, at least prior to just recently. So that eats 2 of the remaining 3%. That leaves just 1% for me to live on.
That means 1 million dollars of principal gives me just $10,000 to spend each year. My personal needs to live “comfortably” are $150K/year with a paid-for house. So I need $15 million to live off the interest. Your personal definition of “comfortable” will probably be different, and your local cost of living will affect that too. But the basic 1% spendable per year is universal.
Naturally, if I can increase the yield after taxes and inflation from 1% to 2%, I can live just as well on $7.5mil. This is how people convince themselves they’ll be able to retire on too little money … “If I can make 10% after inflation year in and year out, and assume taxes mostly don’t apply to me, I’ll be fine.”
In recent years many financial planners rule of thumb was that you could extract 4% per year. Mighta been true in the mid 2000s, not gonna be true for the next 5 years.
Now if somebody is old enough, they can really improve their lifestyle by consuming principal, or simply by not reserving income to offset inflation. In either case they are depleting their money & it’s a race to see which runs out first, their money or their life. But if I was 80, I might not be nearly as interested in preserving all my principal as I am today at 50.
Your definition of comfortable, along with the locale will be the main factors.
In many areas of the US you can do ok with $30-$40K a year, pay your bills, feed yourself, clothe yourself, have a decent car, and do nothing more than play world of warcraft all day.
Wanna live in manhattan or san francisco, multiply that by 8.
Too many unknowns. First of all, what’s the rate of return? I used to say if your financial adviser can’t get you 5% for a million dollars, you need a new adviser. Nowadays, I’m not so sure.
Second, define “comfortably.” That million dollars at 5% would yield $50,000 per year, more than I’ve ever earned. I could live quite nicely on that, especially if the house has been paid for. My brother, OTOH, makes well into six figures a year and would feel constrained.
And, yeah, fifty large a year would go a lot further in Manhattan, Kansas than Manhattan, New York.
Hang on a sec! Inflation will reduce the value of the income from your investments, not eliminate 40% of that income! That, combined with the fact that in the previous paragraph you rounded 1.25% to 2%, means that you have dramatically overestimated the amount you’d need to have invested.
Leaving the inflation issue out of if for the time being, for an after-tax net of $150,000, you want a pre-tax income of $200,000 (150/.75=200). Multiply by 20 to get the total investment needed: $4 million.
If you want to protect against a loss to inflation of 2% a year, you can do that by adding 2% to the principal each year. Obviously, the easiest way to do that is to not draw out all of your interest. So you’ll need to start with a larger sum.
It took me a while to figure this out, and I may have done it incorrectly, so someone will correct me if I’m wrong. But by my calculations, if you start with about $8.5 million, you’ll have an after-tax income of almost $320,000, enough to take your $150,000 and add 2% to the principal.
So it costs a bit more to compensate for inflation, but not the extra $6.5 million you were calling for. Also, I just realized I was assuming you’d have to pay tax on the amount you rolled back into the principal, which I think in most cases you wouldn’t. But it’s too late to try and figure all that out now.
So, LSLGuy, since I’ve just saved you at least $7 million, how about a 10% advisor’s fee?
Besides, if you had 15 mill in the bank, you could just withdraw 150k every year and be good for 100 years, not counting any interest at all…
Like those bumperstickers I see on the back of our “Winter Visitors” gi-normous RVs: We’re spending our children’s inheritance
I think it says something about how I was raised that someone needed to point out that spending the principle was an option.
I am a small entrepreneur currently involved in one and soon to be two media companies.
My end goal is to accumulate assets worth about $5MM as that will translate to (roughly) a post-tax/post-inflation interest income of $10K per month in perpetuity. Lady Chance and I think well of our ability to live for the foreseeable future on that amount.
It’s good to have a goal.
This article reckons you need at least £3M (in 2003 £, whatever the 2003 US$ equivalent was) to live comfortably for life, but “comfortably” isn’t lavish.