Living On the Interest from One Million Dollars

March 8, 2010 by  
Filed under Asset Allocation, Commentary, Investment Planning

I made my first retirement plan after my freshman year at college.  Back at home, with one year of college under my belt, my good friend John and I were discussing our plans for the future.  I don’t recall the entire conversation, but I do remember saying “my goal is to accumulate a million dollars, and then cash out and live off the interest.”  I further explained that this plan would generate $50,000 a year since 5% interest seemed reasonable.

The year was 1974.  I came from a blue-collar neighborhood where typical incomes were in the $10,000 to $15,000 range.  Anyone making $20,000 was well above-average.  I believed my plan would overcome inflation, and it was based on an extremely conservative income assumption – living off the interest while never touching the principal.

It was a simple plan, but at least I had a plan.  Many people never stop and think about their retirement income until much later in life.  My plan has evolved over the years:  I am no longer content with a $50,000 retirement income, and I am not relying on interest.

Unfortunately for millions of Americans, their plan is similar to my first one:  accumulate a large amount of money and live off the interest.  They worked hard all their life, perhaps paid off their mortgage, grew a sizable nest egg, and are now counting on it to generate income.  Again, this sounds like a reasonable plan, but let’s look at how it is doing.

The two largest retail money market mutual funds are Fidelity Cash Reserves (FDRXX) with assets of $127 billion and Vanguard Prime (VMMXX) with more than $109 billion.  Funds like these are what thousands of investors and savers count on to generate “risk-free” income.

Just three years ago, in 2007, the plan seemed to be working.  These two funds were yielding 5% and kicking out $50,000 a year for every $1,000,000 (one million dollars) invested.  Today the story is different.  According to iMoneyNet, the current yield (as of 3/2/10) on FDRXX is 0.02% and for VMMXX it’s just 0.01%.  Instead of $50,000 in annual income, these two funds are only providing an average of $150 per year.  That is not a typo, and there are no zeroes missing.

What seems at first like a risk-free plan has at least two enormous risks.  The first is interest-rate risk.  The plan assumed 5% and didn’t take into account that interest rates could drop to nearly zero.  A 99.7% decline in interest income is not only possible, it has happened.

The second unmanaged risk is inflation.  If you think it’s hard to live on $150 a year today, just think what it will be like when oil gets back above $100 and health care costs climb even higher than today.  Lower prices for housing, education, and consumer goods are of limited value to retirees, whose expense patterns do not necessarily match the official inflation rates.

The fact is that money market funds are enormously risky if you count on them for income over long periods of time.  Stocks and bonds are risky, too, but in different ways.  That’s why investment management is a key ingredient for long-term success.

You can’t put all your eggs in one basket and then ignore them, even if that basket is cash,   If your plan is still based on living off the interest, or if it has been a while since you last updated your plan, perhaps now is a good time to review the assumptions and see if they are still reasonable.

Related Resources:

Disclosure covering writer, editor, and publisher: FDRXX is used by our affiliate, Capital Cities Asset Management, as the cash-sweep fund for many non-taxable accounts.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.


6 Responses to “Living On the Interest from One Million Dollars”

  1. Michael Loren on March 8th, 2010 8:41 pm

    Ron, although mm are essentially at 0%, like you pointed out, those of us who plan on living on fixed income need to be more knowlegable about using other forms of fixed income like corporate bonds, tax free muni’s, laddering the bonds, dividend paying stocks, and annuities. The low interest rates we are having to tolerate will eventually return to more normal levels. I remember in the 80′s 10% paying CD’s was what was expected. when interest rates began dropping… I thought 6% how terrible.

  2. Sam Humbert on March 10th, 2010 8:52 am

    The Fed’s holding short-term rates at 0% — far below real-life inflation — is a clever, indirect way for Washington to tax industrious, thrifty people.

  3. mike smith on May 18th, 2010 10:22 am

    Ron, unfortunately they don’t make it easy to complain/write to the Federal Reserve/Bernanke who doesn’t give a rip about retired Americans. Heck even AARP ignores me and I’ve written to them 3 times to use their political clout to bug the gov about the damage 0% is doing to retirees.

  4. Michael Kilgore on March 10th, 2011 12:20 pm

    WHEN I Hit Powerball or Megamillions , I Will figure all of this out … Maybe just cash out and peel a C-Note as I need it !

  5. grant on March 31st, 2011 5:08 am

    well obviously if you had a mill you wouldnt stick in the bank and live of interest…r u nuts…. THe best way to secure your financial future with a mill is to gear up into debt, I would spend at least 3 mill on property that is a combo of neg geared for growth and pos geared for income.. (which means you dont need a high income to borrow that with a mill)…in they way your rent covers cost and you get cap growth so 3 mill becomes 6 in 7 -10 years and 12mill in 14 -20 but by then you should have geared up again and have at least 40 mill in assests but a debt of say only 6mill……….that should be enough to retire on ;) pass on the assets to your kids, etc…

  6. grant on March 31st, 2011 5:25 am point here is that the weathly and investor savy dont use there money to build wealth, they use the banks, they also minimise tax by using gearing so that they pay for things with before tax dollars not after tax dollars.. then pay tax on whats left over.(need more space to tell you how that works). they preduce tax free income thru geared investment and they maxmise there returns by leveraging of there assests to borrow to buy more income and capital producing assets… You cant make money real money by saving and puting it in the bank to earn limited interest for which you then pay tax on that….ASk yourself how long would it take to save a mill? but if you had borrowed say 300k with a 50k deposit ten years ago and invested wisely even on an average wage you could have a (net) mill in equity by now and about 2 mill worth of assets if you had borrowed against the growing capital of the first investment, and you would have assets growing at around 200k a year on average….

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