Investing 101 Can You Live Off the Interest of a $1 Million Dollar Investment? Read the Article Open Share Drawer Share this:Click to share on Twitter (Opens in new window)Click to share on Facebook (Opens in new window)Click to share on Tumblr (Opens in new window)Click to share on Pinterest (Opens in new window)Click to share on LinkedIn (Opens in new window) Written by Matthew Amster-Burton Published Jun 18, 2013 6 min read Advertising Disclosure The views expressed on this blog are those of the bloggers, and not necessarily those of Intuit. Third-party blogger may have received compensation for their time and services. Click here to read full disclosure on third-party bloggers. This blog does not provide legal, financial, accounting or tax advice. The content on this blog is "as is" and carries no warranties. Intuit does not warrant or guarantee the accuracy, reliability, and completeness of the content on this blog. After 20 days, comments are closed on posts. Intuit may, but has no obligation to, monitor comments. Comments that include profanity or abusive language will not be posted. Click here to read full Terms of Service. Save more, spend smarter, and make your money go further Sign up for Free Lately, everyone seems to be talking about a million dollars. For example: “A million dollars isn’t what it used to be,” the New York Times reports. For now, let’s sidestep the debate about whether a million dollars is a lot of money or not and focus on a question we’ll all face at some point, if we’re lucky: how to live off a sum of money. To make the issues simpler to understand, forget retirement. Let’s say you inherit a million dollars from your rich uncle or sell your internet startup, and you want to live off the interest for the next 30 years, without putting the principal at risk. In other words, you don’t want to end up like the CNET founder who blew $200 million in five years and is now in bankruptcy. You already know how to avoid that fate: buy fewer houses and racehorses. But how far can the interest on a cool mill actually take you? Let’s look at what you might do with the money if preserving the principal is your main goal. (Note: This exercise was inspired by a blog post by my friend Glenn Fleishman, a man who thinks big; his post is about what to do with $5 million.) Buy a 30-year US treasury bond. Current rate: 3.33%. Great. You collect $33,300 a year. Yikes. That’s not even enough for one measly thoroughbred. Actually, it’s even worse than that. The $33,330 isn’t adjusted for inflation. Assuming 3% inflation, in 30 years that payout will be worth $13,590—and your $1 million principal will be worth about $412,000. So you want inflation protection. Okay, so buy a 30-year Treasury Inflation-Protected Security (TIPS). Now your interest rate is 1.06%. You get $10,600 per year, and both the interest payments and principal are adjusted for inflation. That’s fine, but who can live on $10,600? Buy a 5-year CD I hope interest rates are higher when it’s time to renew, because rates really stink right now. You can get a CD paying 2%. That’s $20,000/year, not adjusted for inflation. Yuck. Furthermore, this strategy leaves you completely at the mercy of interest rate fluctuations. As you know from living through the last ten years, interest rates are as volatile as a drunk uncle at a wedding. Short-term interest rates in 2007 were 100 times higher than they are now, and 5-year rates were over four times as high. If you’re living off income from your portfolio, what are you supposed to do, live like a rap star when interest rates are high and subsist on bread and water when they’re low? Okay, maybe you’d rather take some risk to squeeze more income from your portfolio by doing something like this… Buy dividend stocks. These have been very popular lately, so much so that you’re not going to find a lot of income in them. Vanguard’s Dividend Appreciation ETF(VIG) currently yields 2.11%. Not much better than a CD, and nothing about it is guaranteed: companies can suspend dividends, and the stocks can tumble like any other stocks. Buy high-yield bonds. SPDR’s junk bond ETF (JNK) yields 4.97%. That’s the best number we’ve heard all day. Naturally, higher return is accompanied by higher risk: junk bonds plummeted during the financial crisis. Something is wrong here, and it’s not just the fact that interest rates are appallingly low. It’s that trying to squeeze “income” from your portfolio is a mental mistake that leads to bad decisions. Total return Investors love income. We’re excited by high interest rates and big stock dividends, and we consider them different from the money we make when a stock or bond goes up in value. A $100 dividend or interest payment feels like money we can spend; a $100 increase in the value of our stock holdings doesn’t induce us to sell; it might encourage us to buy more. This mental distinction is usually a mistake, because what matters is how much money you have and how it’s invested, not whether the source of the money was dividends, capital appreciation, or a $25 check from Grandma. Investors who focus on wringing more income out of their portfolio often end up taking additional risk without realizing it. Yes, junk bonds, dividend stocks, insurance contracts, and peer lending offer higher yields than CDs. They also offer higher risk of one kind of another, usually default risk (the risk that your loan won’t be repaid), liquidity risk (you won’t be able to get your money back when you want it without paying a substantial fee), and market risk (the value of the stock or bond goes down, and you have to sell at a loss). Trying to preserve your capital and earn more income by using these kinds of products isn’t always a bad idea, but it’s a strategy often pursued by people who are averse to owning stocks and believe they’re taking less risk by owning bond-like products. It’s like driving your car because you’re afraid of flying: it provides the illusion of lower risk. The sad fact is this: if you want to set aside a large sum of money for five years and be sure of getting your principal back, adjusted for inflation, you can’t do it. It’s not possible. Interest rates are too low. How to spend $1 million So you have to rethink what you’re trying to do. Do you need to spend the money? If so, how long do you want it to last? How much investment risk are you comfortable with? If you simply want to set the money aside for a future date and take the minimum possible risk, a TIPS bond (perhaps along with the maximum helping of I-bonds) is the way to do that. If you want to make regular withdrawals from the money, you’ve entered into the realm of predicting the future, because you can’t know how much can be safely withdrawn from your portfolio without knowing future interest rates and investment returns. If you knew that, you’d be like Biff in Back to the Future II. Since you’re not, all you can do is own a diversified portfolio and take an educated guess. Based on past worst-case scenarios, a 4% withdrawal rate has preserved a portfolio for 30 years, but the future could be worse than the worst of the past. What doesn’t make sense to me is the false-sense-of-security approach involving dividend stocks, insurance products, high-yield bonds, and other things that smell safer than they are. True, I’ve never inherited $1 million. But I’ve never lost it either. Matthew Amster-Burton is a personal finance columnist at Mint.com. His new book, Pretty Good Number One: An American Family Eats Tokyo, is available now. Find him on Twitter @Mint_Mamster. Save more, spend smarter, and make your money go further Sign up for Free Previous Post Gift Ideas to Help Your Grad Start Off on the… Next Post Is Cash the Most Underinvested Asset Class? Written by Matthew Amster-Burton More from Matthew Amster-Burton Browse Related Articles Financial Planning Are You Drinking a Million Dollar Latte? Financial Planning The Trouble With Retirement Calculators Investing 101 TIPS for Beating Inflation Saving 101 Are You Sure You’re Getting A Good Deal? MintR… Financial Planning The Lifetime Costs of Pets Family Finances MintFamily With Beth Kobliner: Financial Literacy for t… Saving 101 Budgeting In a Micropayment World Retirement 101 Chapter 01: How Much Do I Need to Retire? Financial Planning The 3 Ms to Paying Down Debt WTFinance WTFinance is Company Valuation?