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Most adults have the goal to build enough of a nest egg to retire comfortably. However, achieving retirement has become a more difficult personal finance venture with a longer average life expectancy, less access to guaranteed income, and Social Security retirement benefits facing funding challenges.
You need a strategic plan, and the earlier in life you make the plan, the better. Once it is time to leave the workforce, you may be wondering if living off interest you accumulate from your savings and investment accounts is possible.
The short answer is yes, but there are several factors you need to plan for to do so successfully. This guide covers how to live off interest earnings and how much you may need to set aside to achieve this goal.
In this guide:
- How Much Money Do You Need to Live Off Interest
- Balancing Risk and Reward
- Creating a Diverse Portfolio (With Examples)
- When it’s Time to Retire
How Much Money Do You Need to Live Off Interest
The first step in figuring out if you can live off your investments and savings is to determine how much you need to cover your expenses. That begins by working backwards in a sense. Start by calculating the cost of your current required and desired expenses. Required expenses are for necessities like housing, health care, and food. Desired expenses are luxuries like travel, entertainment, and possessions.
Once you determine your ideal monthly or annual income goal, you can more accurately predict if your current wealth can sustain this for an extended period of time.
One of the reasons working backward may seem complicated is due to the longer life expectancy we all have. Modern medicine and technology advancements in health care are extending lifespans. This means your wealth may have to last for a significant period, perhaps 20 or 30 years after you leave your job. Multiplying the number of anticipated years in retirement by the annual cash flow can help indicate if your current savings and investments are enough to survive comfortably.
You should also factor in income in addition to your retirement savings and investments. Social Security is still in play for nearly all American workers, but the amount varies based on your income and date of birth. You can estimate your Social Security by visiting the SSA website, or by reviewing the Social Security statement you receive in the mail.
If you are expecting a pension or other payment in retirement, evaluate these income streams as part of your retirement income as well. These evaluations may seem overwhelming, but financial advisors are available to help you.
Balancing Risk and Reward
When considering investments and savings, and the interest you may need to live comfortably in retirement, think through the risk spectrum. Think of investments falling on a straight line, with one end being low- to no-risk investments and the other end being high-risk investments.
High-interest savings accounts, certificates of deposit, and some bonds fall on the lower end of the spectrum, while stocks, real estate, and alternative investments fall on the high-risk end. With more risk, you have the potential to earn more of a reward in terms of interest, dividends, or growth.
However, taking on more risk means you could potentially lose your investment. Lower-risk investments provide stable, safe returns, but at a much lower rate than higher-risk options.
If you are planning on living off interest earnings, it is important to manage these risks in-line with your income needs and overall tolerance for account fluctuations.
Creating a Diverse Portfolio
Most financial experts recommend investors and savers create a diverse portfolio that balances various investments with different risk levels. This means combining different assets that provide varying levels of returns.
Diversification is one of the most foundational aspects of investing, and it becomes that much more important when you plan to live off interest alone. While it is the key to long-term investment success for many individuals, it often requires the help of a professional.
Here are a few examples on how to live off interest. These strategies highlight risk and the need for diversification.
Interest on $100,000
If you only have $100,000, it is not likely you will be able to live off interest by itself. Even with a well-diversified portfolio and minimal living expenses, this amount is not high enough to provide for most people.
- Investing this amount in a low-risk investment like a savings account would generate between 2 to 2.50% of interest each year, or $2,000 to $2,500.
- Investing in stocks, which may earn up to 8% per year, would generate $8,000 in interest.
- Bond investments may generate 2% to 4% per year, resulting in no more than $4,000.
Interest on $300,000
Having $300,000 set aside to retire may be more feasible to live off interest, but diversification and risk still plays a crucial role in how much you will generate.
- From savings, an account paying 2% in interest would provide $6,000 each year in interest.
- Conservative stock investments in that amount could generate 4%, providing $12,000 per year, while those paying 10% would offer $30,000 in income.
- And $300,000 in bonds paying 2.87% would pay $8,610 in interest.
Interest on $500,000
An investment of $500,000 may get you much closer to your income needs in retirement. Based on similar examples as above:
- A savings account paying 2% provides $10,000 each year in interest.
- Stocks with 4% gains generate $20,000, while those generating 10% returns provide for $50,000 in interest.
- Bonds with 2.87% interest rate would offer $14,350 per year in interest income.
Interest on $1,000,000
Many investors target $1,000,000 as the magic number for retirement. Here’s how the numbers break down.
- Earning 2% on a savings account, you could receive $20,000 in interest each year.
- Conservative stocks paying 4% generate $40,000, while higher-risk stocks averaging 10% generate $100,000 in interest.
- Bonds paying 2.87% generate $28,700 in interest each year.
When it’s Time to Retire
You can see that living off interest in retirement depends on several factors, including how much you have saved and invested, and the amount you need to cover basic and extra expenses throughout your lifetime.
Create a realistic picture of your retirement lifestyle and determine the most appropriate time to retire. Also, remember that there could be more expenses later in life due to medical issues, or a need for long-term care services. Include these unknowns when figuring out when you can retire comfortably.
You can live off interest alone, but you need to be careful about understanding your expenses and your current and future assets.
Also, remember that investment returns are not guaranteed, and the more risk you take on to achieve a higher return, the greater your probability of losing some of your investment. Be sure to consider these factors closely before deciding to retire and live off interest income alone.
Author: Melissa Horton