Living off $500 grand
Is it possible to live off the interest from $500,000? I'm single and 57 years old.
NEW YORK (CNNMoney.com) - I sold a commercial property I owned and after paying off the mortgage on my condo I expect to have about $500,000 left over. Is it possible to live off the interest from $500,000? I'm single and 57 years old.
-- Karen Snipes, Roseville, Michigan
Well, I guess that depends on how long and how comfortably you expect to live.
You've also got to factor in whatever other resources you have available. I assume you'll qualify for Social Security, which you can begin taking as early as age 62, although you'll get larger payments if you wait. (For a quick estimate of your Social Security benefits, click here.
And if money begins to get tight, you can always consider generating extra cash by taking out a reverse mortgage on that condo. (For more on that option, see the recent column I did on reverse mortgages.)
But you don't say whether you have other assets, if any, you can draw on (mutual funds, a 401(k) or IRA account, etc.) or whether you qualify for a company pension payment from an earlier job.
So let's limit ourselves to that half-million-dollar stash you expect to have soon and see just how much annual income you might reasonably expect from it.
Living off your stash
One way to think of living off this pot of cash is much the way you suggest in your question: buy an investment that throws off steady income and spend the interest. But given that rates on long-term government and high-quality bonds are in the 4.5 to 5 percent range, you're not talking about a very big income here -- maybe $25,000 or so tops.
Since you've paid off your condo mortgage, you won't have a big monthly housing payment hanging over your head. Still, there are plenty of other expenses you'll have to shell out bucks for during retirement, including property taxes, condo fees, maintenance, a host of other living expenses (all god's children got to eat) and, of course, health-care, which can be a biggie in your case since Medicare doesn't even kick in till age 65.
But even assuming your twenty-five grand plus whatever else you have coming in can handle those expenses today, you've got to consider the effect of inflation. Even if inflation crawls along at a snail-like pace of 2 percent a year, the effect of compounding will have driven prices overall almost 50 percent higher after 20 years. That means when you're 77, you're going to need a lot more than $25,000 a year to maintain the same purchasing power and standard of living.
Which is why I think you should think a little bit differently about how to handle your 500 large.
Here's what I suggest: Instead of investing your money in bonds or some other vehicle that pays regular interest, build a diversified portfolio that includes both stocks and bonds (or, more likely, stock funds and bond funds).
The big advantage to this approach is that the stock portion of your portfolio has the potential to grow a lot more than bonds alone. And that growth will allow you to increase the amount you withdraw from your portfolio as you age, which in turn will help you maintain your purchasing power in the face of inflation.
The bonds play an important role too, however. They add stability, which is important since you don't want to see the value of your savings decimated by a market downturn.
By putting together a diversified portfolio of this sort, you vastly increase the chances that your portfolio can generate a decent stream of income that will rise with inflation -- and that your savings will be around long enough to carry you through a long retirement. These days, I think it makes sense to plan on living until at least 90 or 95, which means you should figure on your stash having to last a good 35 years or more.
Don't draw too much too fast
Investing some of your money in stocks is one way to help assure that you won't outlive your portfolio. But you'll also increase your portfolio's longevity -- and your sense of security -- by taking care not to draw too much from your portfolio, especially early on.
As a rule, you should probably limit yourself to a withdrawal of 4 percent of your portfolio in the first year, and then increase your draw in subsequent years for inflation.
In your case, that would mean pulling $20,000 from your portfolio at first. Then, assuming inflation is running 3 percent per year, you would increase your next year's withdrawal to $20,600, and the next year's draw to $21,220 and the next to $21,850 and so on.
That's not to say you couldn't start out drawing a bit more -- or, for that matter, varying your withdrawals somewhat to meet changing income needs -- but you want to be careful not to siphon off too much of your assets early on.
For more on how to build a portfolio that can make your money last and for guidance on how to manage withdrawals, I suggest you take a look at MONEY's recent Dream Retirement special report. While you're at it, you might also want to check out T. Rowe Price's Retirement Income Calculator. It can give you a good sense of how long your money is likely to last at different withdrawal rates and with different mixes of stocks and bonds.
I realize that the approach I'm advocating involves more effort than just throwing your money into a bond fund and hoping for the best. But better to put the time and effort in today than to find yourself in the unenviable position of having to adjust to a much lower standard of living 20 years from now.
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