After saving and investing for a long time, naturally you would like to start using your investments for income. This might be at retirement, when your investment portfolio will be your main source of income unless you have a large pension. It might also be earlier in life when you’re looking to start supplementing your income from your job with investment income, or even using investment income for life expenses while you start a business. The question is, how much can you draw from a savings/investment account without seriously depleting the account? If it is a retirement account that you want to last through your retirement, how much can you draw without outliving the money?
One way to start to estimate how much you can draw is using a payment calculator, for example this one here. For example, let’s say that you have saved $1 Million and you want the money to last at least 30 years. You would plug-in $1,000,000 to “loan amount” and “30 years or 360 months” into the loan term blanks in the calculator. If you are investing in stocks, you might choose 8% or 10% as the interest rate. The lower the rate you choose, the more conservative you are being.
So, assuming an interest rate of 8%, the calculator shows a monthly payment of $7,338. This means that if you received a steady return of 8% per year, you could withdraw about $7300 per month and have the money last 30 years. The issue though is that with stocks and bonds, the return will not be steady. It will be up 20% one year and down 10% the next. The account will also decline in value due to inflation, so that $7300 you receive the first year might only be worth $4000 by the time you withdraw the last payment in 30 years.
For this reason you therefore don’t want to withdraw the whole amount each month. You want to withdraw some of your gains and leave part to grow and makeup for the losses to inflation. You might therefore only withdraw $5000 per month, or even $4000, instead of the full $7300.
Another factor to consider is that the more money you have, the more risk you can take and therefore the higher the rate of return you could assume. If you could survive on $5000 per month, but had $3 million in investments, you might choose to invest $1 million conservatively, to ensure that you could meet your minimum income needs of $5,000 per month, but then invest the other $2 million in more aggressive growth stocks. You might therefore be able to assume a higher return, of say 12%. Putting $3 Million at 12% for 30 years into the calculator, you get a monthly payment of almost $31,000 because of the higher return. (Note, this is the reason you should save and invest to have a lot of money at retirement. In addition to providing a higher return in general, it allows you to generate higher returns on your money.)
A final consideration is the way in which the money is withdrawn for income. If a good portion of the portfolio is invested in income stocks and bonds, money will be generated throughout the year at a fairly predictable return and can be readily withdrawn. With a portfolio of growth stocks where the main way of generating income is to sell stocks, however, the returns from one year to the next are far less certain.
If you are just using the account for supplemental income to your day job, you could choose to just withdraw income as you have opportunities. As one approach, in years when the account has a positive return of 8% or more, you could withdraw one-fourth of the profit. For example, if you had a million dollar account and it earned 10%, or $100,000 one year, you might take $25,000 out and use it for a trip, a new used car, and home improvements. On years when it earned less than 8% or even lost money, you could leave the account alone and allow it to grow. In this way you would be taking profits during the good times and allowing the account to recover during the bad times.
If you are using the account for retirement income, you’ll need cash for expenses even on years when the market is down. A strategy here is to save up cash when the times are good and then use that cash on years when the times are bad. For example, you could sell enough shares initially to have 5 years-worth of expenses in cash and put that money in a set of CDs. On years when the market does well, you could sell some shares (again, maybe 1/4 of the profits when the account returns more than a certain percent) and build up a cash position, perhaps building up as much as 10 years-worth of cash in CDs before just letting the gains run.
On years when the market does poorly, you could just spend the money from the CDs until it reached a minimum threshold, maybe 1 years-worth of expenses, at which point you would sell enough to gather at least 3 years-worth of cash. Because the market generally recovers within a year or two of declines, it is very likely that you will be able to maintain enough cash for expenses and avoid selling when the market is substantially down this way.
Contact me at firstname.lastname@example.org, or leave a comment.
Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.