Living like a millionaire

Kelly Rodgers, MoneySense October 2002

LET'S FACE IT, we all have the same fantasy. We inherit a million dollars from an uncle we've never heard of, and we immediately say goodbye to the workaday world. No more regular jobs for us. We become rentiers, collecting the income generated by our substantial investments while we do nothing more strenuous than lounge on a beach or play golf.

But how much money do we really need to leave the workforce behind and live solely off our investments? You'd better sit down for this. Once the dreams are put aside and the calculations are made, you'll discover that even a cool million won't do.

Remember, if you part ways with your job before you turn 60, you'll have to rely upon your own resources to supply your current needs. No government benefits, no pension. So the first thing to do is to calculate how much money you and your spouse will require in a typical year of early retirement. For simplicity's sake, let's assume you've paid off your house and put your children through school. If you're OK with the idea of living a reasonably middle class existence, $50,000 a year (before tax) should do you fine.

Here's the challenge: you must earn this $50,000 solely from dividends, capital gains and interest on your investments, since full government benefits won't kick in until you turn 65. Furthermore, you must provide for inflation. Looking back over the past few decades, the best return you can realistically expect from a balanced portfolio of stocks and bonds is 5% a year after inflation.

But that doesn't mean you can withdraw 5% from your portfolio every year. If you did, you could wind up destitute if stock markets suffer a sustained period of bad returns. Withdrawing $50,000 a year from a portfolio that is steadily shrinking in value during a multi-year bear market could leave you penniless before the market recovers.

So how much money can you withdraw while keeping the purchasing power of your nest egg intact? In 1997, researchers at Trinity University in San Antonio, Tex., crunched decades of historical data to calculate an answer to this question. It turns out that you're asking for trouble if you withdraw more than 5% a year from a balanced portfolio. Indeed, if you're going to be a rentier for 20 years or more, you should probably stick to a withdrawal rate of just 3% to 4%. (You can find out more about this fascinating Trinity study by reading Scott Burns, a columnist with The Dallas Morning News, at www.dallasnews.com.)

If we take 3.5% as a safe withdrawal rate, you would require a nest egg of -- get ready for it -- about $1.4 million to live the frugal life of a middle-class rentier. Yes, you could probably get by on slightly less if you were willing to live very close to the bone. But the point remains the same. Unless you have a very large fortune stowed away in a balanced portfolio of stocks and bonds, you're stuck working along with the rest of us.

The consolation is that you will be able to retire. Government retirement benefits are exceptionally generous in this country. You'll need nowhere close to $1.4 million to support a comfy middleclass retirement if you're willing to work until you're 65. If you retire with a paidoff home and an empty nest, savings of about $830,000 should produce income of $29,000 a year for decades without affecting your original portfolio. Government benefits, amounting to a minimum of about $21,000 a year for a retired couple, will take care of the rest of your needs. Don't have $830,000? Don't worry. You can get by with far less if you're willing to eat up your capital, as most of us do.

The real problem is getting to 65 without undue stress. Indeed, there is a very simple moral to this column -- working at a job that you enjoy is tantamount to sitting on a huge pile of wealth. If you earn $50,000 a year doing something you really like, you're as well off as the fellow who is living off the income from a $1.4 million fortune. Even a job that pays just $20,000 is equivalent to the annual income from a $570,000 fortune, Instead of trying to outwit the stock market, find something you like doing and stick to it. You will be living literally -- like a millionaire.