When I was a kid, a million dollars was inconceivable to me. It was the amount of money that made you special; you went from being a regular person to being a ‘millionaire.’ I wanted to be part of that club!
As I’ve grown, I’ve realized a lot of people become millionaires without having to invent an app or become a movie star. Through saving and investing, most people can become millionaires. In fact, far from being a financial pinnacle, now people are asking if a million dollars is enough money. Can you live off the interest an investment principle of a million dollars provides or do you need more?
According to the Census ACS survey, the median household income for the United States was $55,775 in 2015.
If you have a million dollars invested, you can withdraw 6% to live off $60,000 a year, slightly more than the median income. However, if you withdraw that amount from the principle each year and don’t replace it, you’ll run out of money pretty quickly.
But wait! What about the interest? If your portfolio makes 6% or more in interest, you can safely withdraw that amount without touching the principle.
This is called an interest-only withdrawal strategy; you invest in interest earning holdings and only spend the interest that you earn. However, it’s easier said than done. Living off the interest of a million dollars isn’t impossible, but it depends on a few things.
The Problem with Interest-Only Strategies
The market is an unpredictable beast. It will go up and down, and it’s very difficult to predict how and when that will happen.
You may have a year where you earn 10% interest, followed by a few years where you earn only 4% interest. The effect the market has on your portfolio will effect the amount of interest you earn, and you have little control over the market.
Inflation is also a concern. Inflation generally grows at 3% per year. That means that your money loses a little bit of value year to year if it doesn’t grow at the same rate. $55,775 today will actually be less next year, and the year after. So for people planning to live on interest-only plans, you need to consider the rate of inflation in your calculations. Inflate your income needs through your entire life expectancy to come up with an accurate living expenses number.
The final problem as I see it with this strategy is the principle. In order to keep living off of the interest of a million dollars, you need to keep your principle at a million dollars. If you take anything out of the principle it will effect the interest rate.
Say you take $20,000 out of your principle to help your child with college. Now instead of a million dollars, you’ve only got $980,000. A 6% interest rate on that number is only $58,800. If you need $60,000 a year to live on, you just lost a chunk of your annual income.
How to Make it Work
This plan so far doesn’t include a couple things. For one, we haven’t mentioned social security. While it’s likely that social security will change over the next 30 years, most people can still expect something from it to augment their retirement income.
Secondly, you can make an interest-only strategy work by having more than one million dollars in your investments OR by needing a lower percent of interest to live off of.
Investopedia has a great example of how to make this strategy work.
“A true interest-only strategy can work only for those with excess capital. If you retire with $1 million but only need $55,000 per year of supplemental income, keeping with our 6% assumption, you will need $917,000 to produce your income. That will leave you with $83,000 that could be used for emergencies or irregular expenditures.”
Like many early retirement blogs will tell you, the less you need to live on the more flexible your money becomes. So if you’re interested in living off the interest of on a million dollars, lower your annual income needs while maintaining your portfolio principle.
Looking for more great articles on how I handle my money? Try these articles:
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