Mere Millionaires Need Not Apply

Nurturing a secret fantasy of avoiding the indignity of work by winning the lottery? Then gird yourself. You’re going to have to win really big. It has never cost more to be somewhat well off.

According to my Life of Riley Index, you need a record $4 million, up from $3 million only two years ago, to be independently upper middle class. Note that I did not say “independently wealthy.” The Life of Riley Index doesn’t aim so high, it just measures the income and capital needed to be better off than most.

How much is that? Well, it’s an arbitrary amount, consistently measured. My index identifies the amount of money you would need to produce the dividend and interest income needed so you could spend more than 75 percent of the households in America. For 2011, I estimate that at about $72,377.

That’s more income than most people enjoy, but not exactly a life of luxury. Indeed, some urban readers will wonder how they could possibly survive on so little money. Since it would take $4 million to produce that income, the growing media focus on billionaires isn’t surprising. Millionaires are so 1950.

Here’s how the index is calculated. Every year I assume that a would-be Life of Riley person puts half his money in a 5-year Treasury note. He puts the other half in the Standard & Poor’s’ 500 Index stocks. I calculate the income yield on the portfolio. Then I go to the Internal Revenue Service statistics of income and check how much income you would need to be at the threshold for the top 25 percent of all households. (Note: I estimate the figure for the current year because the last IRS figure is based on tax returns from 2008.)

Divide that income figure, $72,377, by the portfolio yield—a piddling 1.77 percent this year— and you know how big a nest egg you would need to live on its dividend and interest payments. This is the way we might live if we had been more attentive when we selected our parents.

Needless to say, it hasn’t always been this expensive to be independently better off than most. The combination of rising income from our jobs and declining income from our savings has caused the Life of Riley Index to rise far faster than the rate of inflation. Here are some examples:

  • In 1989, only 22 years ago, the income requirement was only $36,839 but the yield on the S&P 500 was 3.45 percent and the yield on 5-year Treasury obligations was a whopping 8.5 percent. So you only needed $616,552 to live the Life of Riley.
  • By 1999 the big tech bubble had brought the S&P 500 yield to only 1.25 percent— less than its current 2.00 percent— and the yield on 5-year Treasury obligations was down to 5.54 percent. Fortunately, the income required was only $52,965. As a result, the required portfolio was $1,560,088.
  • By 2006, the year the housing bubble broke, the S&P 500 index yield had climbed back up to 1.87 percent while the yield on a 5-year Treasury had declined to 4.75 percent. Fortunately, the income threshold had only risen to $64,702 due to a lousy job market. So you needed $1,954,743 to live the Life of Riley.
  • Today, only 5 years later, you’ll need $4,089,096. That’s twice as much. The cause isn’t a rapid rise in the income threshold because jobs and wage gains are still scarce. It is the continuing and unnatural decline in investment yields. Today the S&P 500 index yields 2 percent while a 5-year Treasury yields only 1.53 percent. (To see a complete 1986 to 2011 table of Life of Riley Index figures, please visit my website, www.assetbuilder.com)

You can, of course, reduce the amount of money required by increasing the portfolio yield. This can be done by adding REITs, dividend stock ETFs and junk bond funds that offer higher yields at greater risk. But the basic reality remains— whether you dream of being fabulously rich or living the Life of Riley, you will need an enormous amount of money.

Next week, we’ll see how this applies to retirees…and learn the importance of Social Security.

The Life of Riley Index

or, how much money you need to be independently upper middle class)

This table shows how much you need in financial assets to produce an income at the 25th percentile of all American households. The actual amount could be changed by substituting investments with different yields than the S&P 500 index and 5 year Treasury note that are used in this example.

Year S&P500 Yield 5Yr Treasury Yield 50/50 Portfolio Yield Top 25% AGI Threshold Portfolio
Required
1986 3.49% 7.30% 5.40% $ 32,242 $597,627
1987 3.08% 7.94% 5.51% $ 33,983 $616,751
1988 3.64% 8.47% 6.06% $ 35,398 $584,608
1989 3.45% 8.50% 5.98% $ 36,839 $616,552
1990 3.61% 8.37% 5.99% $ 38,080 $635,726
1991 3.24% 7.37% 5.31% $ 38,929 $733,817
1992 2.99% 6.19% 4.59% $ 40,378 $879,695
1993 2.78% 5.87% 4.33% $ 41,210 $952,832
1994 2.82% 6.68% 4.75% $ 42,742 $899,832
1995 2.56% 6.77% 4.67% $ 44,207 $947,631
1996 2.19% 6.07% 4.13% $ 45,757 $1,107,918
1997 1.77% 5.77% 3.77% $ 48,173 $1,277,798
1998 1.49% 5.15% 3.32% $ 50,607 $1,524,307
1999 1.25% 5.54% 3.40% $ 52,965 $1,560,088
2000 1.15% 6.15% 3.65% $ 55,225 $1,513,014
2001 1.32% 4.55% 2.94% $ 56,085 $1,910,903
2002 1.61% 3.82% 2.72% $ 56,401 $2,077,385
2003 1.77% 2.97% 2.37% $ 57,343 $2,419,536
2004 1.72% 3.43% 2.58% $ 60,041 $2,331,689
2005 1.83% 4.05% 2.94% $ 62,068 $2,111,156
2006 1.87% 4.75% 3.31% $ 64,702 $1,954,743
2007 1.86% 4.43% 3.15% $ 66,532 $2,112,127
2008 2.37% 2.80% 2.59% $ 67,280 $2,597,683
2009e 2.40% 2.20% 2.30% $68,289 $2,969,087
2010e 1.98% 1.93% 1.96% $70,474 $3,595,612
2011e 2.00% 1.53% 1.77% $72,377 $4,089,096