Do you want to play and live truly free? Here is how to produce income from investing to live off of forever.
In order to produce the investment income that you can live on for an indefinite period, you need to establish the amount you will need each year. Essentially, determine the how much investment income you want your investments to provide. After which, accumulate and save the present value of this amount to reach your financial goal.
Investment income can be produced from various investments such as stocks, high-yield accounts, businesses, property and many others. However, we will focus on high-yield portfolio accounts to determine how much you can safely withdraw. Specifically, we need to determine just how much is enough to withdraw from your portfolio to ensure that it lasts forever.
Annual Income Withdrawal Rate
What is the best withdrawal rate per year? A common rule of thumb is to withdraw no more than 4% per year.
Here is a table that shows how much withdrawn income that different portfolio sizes can generate at different annual withdrawal rates:
Note: Annual Income Withdrawal
- 3% – 4% rate is considered okay or fairly safe for the perpetuity of the portfolio.
- 5% and above increases the risk of eroding the investment capital tremendously.
In reality, your withdrawal rate depends on the rate of return your portfolio provides. For instance, if you have put your funds in bonds and treasuries that provide a return of about 8-12% per year, and inflation is about 6% per year, then, of course, you cannot withdraw more than 4% per year without reducing your initial investment.
Let’s take a look at the Kenyan stock market. With a rough estimate of an average performance of the NSE at 10% for the last decade, then the common rule of thumb of withdrawing 4% per year would be too aggressive since inflation will be eating away on your initial capital faster than your investment replenishes itself.
Calculating the Maximum Withdrawal Rate
To ensure the perpetuity of the portfolio, we must consider the current inflation rate and the annual return of the portfolio. We subtract the two and then withdraw the remainder. This constitutes the maximum withdrawal rate.
Maximum Withdrawal Rate = Annual Return Of Return – Annual Inflation Rate
For instance, if your portfolio is growing at 10% per annum and the current inflation rate is at 6% per year, then do not withdraw more than 4% every year. This way, your portfolio will keep growing as fast as inflation to maintain its inflation-adjusted size, while you continue to withdraw 4% of it per year. Ensure that you compute this every year you consider withdrawing as economic changes with affect these factors.
However, there is a safer rate of withdrawal which you can use and is computed as follows:
Safe Withdrawal Rate = Annual Return Of Return – Annual Inflation Rate – 1%
Final Thoughts
There are various high-yield accounts that you can put your money in to generate good passive investment income. Ensure that you do not invest too conservatively as this will create additional risk for you. In other words, if your rate of return is too low and you are withdrawing 4% or more of it every year, you may run out of money faster than you think. Consequently, you need to adjust your withdrawal amount with your relative expected rate of return and try to plan your withdrawal levels for it to last forever since you do not know how many decades you may live after you stop working.
Meanwhile, You can click on the following links to read more about financial planning:
- 5 Habitudes of Successful Wealth Builders
- Leverage: The Key to Amassing Wealth
- How To Make A Budget
- How to Get Out Of Debt Successfully
- How to Build Wealth Rapidly
Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.