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June 24, 2016

To Live Well, You Need Lots of Money

The cost of living higher on the hog has risen again. Nothing wild, mind you. It’s just what happens when yields on stocks and bonds decline. The lower they go, the more investment cash you need. This year the Life of Riley Index has a price tag of \$4,774,478. That’s an increase of 8 percent from last year’s \$4,417,720.

Missed that memo? Well, the Life of Riley Index is my attempt to track how much money you need to live well without the indignity of work.

Here’s how I calculate the index. First, I estimate the income you would need to rank at the top 25th percentile of income. The basic data comes from our friends at the Internal Revenue Service. As you know, the IRS has a deep interest in the amount and distribution of our income.

Every year it does an analysis of our tax returns. The analysis ranks income level by percentile. You can download this information, free, from the IRS website.

Unfortunately, the actual results stop at 2012. I estimate the 2016 income by adding inflation to the last IRS figure. Call me an optimist, but some people actually have incomes that keep up with inflation.

I base the second part of the index on investment yields. The S&P 500 now yields about 2.09 percent, and the five-year Treasury note now yields about 1.16 percent. Together in a 50/50 portfolio, you get a yield of 1.63 percent. That’s down from last years’ 1.75 percent.

It’s also down from the 5.99 percent yield of 1990. And that’s a big problem. The income needed to be in the top 25 percent continues to rise. But the yield on investments has been declining for thirty years. In technical terms, that’s called a “Double Whammy.”

Result: It’s much harder to be a “person of independent means.” How much has the cost of living on investment income soared? Consider some basic figures.

• In 1985 the required income was only \$30,928, but portfolio yield was 7.19 percent. So a mere \$430,452 was enough to make you a person of independent means.
• This year the required income is \$77,824 and the yield is only 1.63 percent. This means you would need a portfolio more than 10 times as large, \$4,774,478, to pay the bills for your top 25th percentile lifestyle.

Discouraging, isn’t it? The cost of living well without working has risen at a compound rate over eight percent over the last three decades.

To arrive at that \$4.77 million figure in 30 years with the same portfolio, you would have needed to save well over \$30,000 a year. That makes living the Life of Riley a “can’t get there from here” situation. If you could save over \$30,000 a year, your notion of a Life of Riley income would be a lot higher than \$77,824.

But stay with me. We may be able to finesse this.

Suppose you take a regular safe withdrawal rate of 4 percent from your portfolio? You’d need less than half as much money, \$1,945,600. That would drop the annual savings need to about \$13,500 a year.

Can we reduce our magic number for financial independence still lower?

Yes, but we’ll have to be old enough to retire and take Social Security benefits as well as a safe withdrawal rate. If your Social Security benefits provide about 40 percent of income, the portfolio need drops to \$1,167,330. That would drop the annual savings need to about \$8,100 a year.

What else can we do to attain the sweet Life of Riley?

We can take more risk. Move to 70 percent U.S. stocks and 30 percent US total bond market and the savings need goes down to about \$7,500 a year. That’s still a lot of money to save every year for 30 years.
Bottom line: To live pretty well, we need lots of money. To have lots of money in the future, we need to save like mad today.

Is there any good news? Perhaps. If you don’t live so high on the hog, saving enough to retire isn’t impossible.

The Life of Riley Index

This index shows the amount of investment money needed to sustain the income required to be at the 25th percentile of U.S. household income, given the ups and downs of interest rates and dividend yields. Columns 7 and 8 show the same income for a withdrawal rate of 4 percent and for a withdrawal rate of 4 percent after Social Security provides 40 percent of necessary income, a common Social Security replacement rate.

 Year S&P 500 Yield 5 Year Treasury Yield 50/50 Portfolio Yield Top 25% AGI Threshold 50/50 Portfolio Required Nest Egg Needed @ 4% Withdrawal Rate Nest Egg needed after 40% Social Security 1985 4.25% 10.12% 7.19% \$30,928 \$430,452 \$773,200 \$463,920 1990 3.61% 8.37% 5.99% \$38,080 \$635,726 \$952,000 \$571,200 1995 2.56% 6.77% 4.67% \$44,207 \$947,631 \$1,105,175 \$663,105 2000 1.15% 6.15% 3.65% \$55,225 \$1,513,014 \$1,380,625 \$828,375 2005 1.83% 4.05% 2.58% \$62,068 \$2,410,408 \$1,551,700 \$931,020 2010 1.98% 1.93% 1.96% \$69,126 \$3,535,857 \$1,728,150 \$1,036,890 2014 1.77% 1.71% 1.74% \$76,687 \$4,407,299 \$1,917,175 \$1,150,305 2015 1.87% 1.62% 1.75% \$77,301 \$4,417,720 \$1,932,525 \$1,159,515 2016 2.09% 1.16% 1.63% \$77,824 \$4,774,478 \$1,945,600 \$1,167,360 Avg PF 3.00% 5.00% 4.00% \$77,824 \$1,945,600 \$1,945,600 \$1,167,360 Sources: IRS data, Economic Indicators, Federal Reserve, Bloomberg data, Author calculations. For 2014 and 2015 the income is estimated by adding the inflation rate to the 2012 income figure in the IRS income analysis.

Notes:

2012 \$73,354

inflation rate 2012=3.0, 2013=1.5, 2014=0.8, 2015=0.7

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This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

AssetBuilder Inc. is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and expenses carefully before investing.