Living Off Investment Interest: The Math Is Easier Than You Think
Retirement can sound like a dream come true for many. Living off investments and residing in places like Port St. Lucie, one of Florida's most scenic retirement towns, can make the forty or more years in the workforce truly worth it. It will, of course, require discipline, and most importantly, the financial know-how to live off investment interest. Fortunately, calculating the savings required to live off investment interest is easy enough, according to Mass Mutual; all you need to have is a rough estimate of your desired retirement income and the expected rate of return.
The formula takes an individual or household's desired yearly income for retirement and provides a rough estimate of how much they should have saved. To find the magic number, divide the expected income amount by your expected investment returns. For example, if you need $65,000 a year during retirement and expect an 8% return on your portfolio, divide 65,000 by 0.08, and you arrive at 812,500. This means that you would need $812,500 saved to get the annual investment interest income you want. This calculation is known as the "perpetuity formula" and is used by businesses to calculate cash flow, but it can also be used for retirement planning.
The math may be simple, but it's based on important assumptions
The formula quickly tells you how much your principal amount should be for the interest income to cover your expected annual expenses. This way, you ensure that your savings can last indefinitely. However, like other fixed withdrawal rules — including the 4% retirement rule — it makes certain assumptions that retirees should be aware of. The most serious assumptions are that individuals or households do not have fluctuating expenses in retirement, get a consistent rate of return, and never tap into retirement savings prematurity (the latter is becoming more common and makes it more likely for retirees to run out of money).
These assumptions can have a big influence on how long retirement savings last. Market volatility alone can delay retirement plans, and many retirees face unexpected expanses, which may force them into making larger withdrawals than they planned. Still, the formula above can be used as a quick calculation for managing your investments. When paired with more detailed planning, it provides a good gauge of whether you're on track to retire and live the life you envision.