You may be wondering how to live off investments, especially in this day and age of extremely low interest rates when your investments don’t earn much income.
Simply put, you can live off investments in one of three ways:
- Spend your savings and the growth from that money
- Spend the income your savings generates for you
- Or live off a combination of these two strategies
While this seems overly simple, I realized that most people aren’t programmed to think about these options. Years ago, I wasn’t either until I ran the numbers to see how we could eventually live off investments during retirement.
After almost 40 years of investing my own money, and creating diversified income sources over the past 15 years from stocks, real estate and online businesses, I’ll share my big aha about how living off investments worked best for us.
Retirement Withdrawals Vs Diversified Income Streams
The mainstream retirement plan calls for withdrawing your money to live. It’s just what we naturally think will work in retirement, because it used to be the norm.
But the numbers have changed based on several factors.
Below are the three strategies for how to live off investments in more detail.
- Spending Your Money, or the “Investment Withdrawal Strategy” – The first way to live off your investments is by saving enough money with the plan that money will grow and compound. The hope is that you can eventually withdraw funds from your investment accounts to pay all your bills, usually later in life.
- Spending Income Your Investments Generate, or the Income Streams Method – The second way to live off your investments is to own income generating assets, such as stocks, bonds, real estate or small business. Owning assets that generate cash flow allows you to pay the bills with the income you get from these assets.
- Investment Withdrawal and Income Streams Combination – The third way to live off investments is a combination of using both funds withdrawn from your investment accounts and the income that is generated from assets that generate cash flow.
How to Live Off Investments Easier
When exploring how to live off investments, it goes without saying that the lower your expenses, the less money you’ll need each month. Spending consciously is always important, but this focus of this article is how to live off investments, not living frugally.
There has been a lot of focus following the Great Recession on drastically cutting expenses so you don’t need much income to live. In my writing, I focus creating the income to maintain the lifestyle “to which you have grown accustomed” while spending smart.
Below I’ll go into more detail about each method for living off investments, but first I want to point out several important factors that can lead to money problems for any of these strategies to live off investments.
4 Warnings for All Three Strategies
Before going into more details about how to live off investments, it’s important to make the following points about your lifestyle expenses. It seems sensible to be cautious rather than to throw caution to the wind when it comes to something as important as your money.
All three strategies to live off your investments require that you:
1. Cover All Expenses – Withdraw or make enough income to cover annual expenses such as property taxes as well as monthly expenses.
Watch my video with my video with more about those pesky seasonal expenses that throw off our cash flow!
3. Consider inflation. Historically, inflation averages about 3% a year over time but it’s been closer to 2% in recent years. Inflation depletes the value of your money. You’ve seen this everywhere from rising prices. A good example is that the movie cost a dime when I was a little girl and now it costs $8 (and isn’t as exciting!)
4. Plan for taxes. Remember that you may need to pay federal or state taxes on the amount you are either withdrawing or earning from your investments. Check with a CPA since this is a complex topic that will vary greatly depending on whether you are:
- Withdrawing money from an IRA, and the type of IRA
- Whether the income is from dividends, interest, or alternative income such as rental income
- Whether or not you have some type of entity, such as an S Corporation, C Corp or LLC, which many people with alternative assets use
- Other income and factors
Now that we’ve addressed the main requirements for living off investments, let’s explore how this is possible with the 3 methods.
1. How to Live Off Investments Using the Investment Withdrawal Strategy
If an investor researches how to live off investments, this is the investment withdrawal strategy is the solution they’ll see most often. The most common way to live off your investments in retirement is by saving enough money so you can withdraw funds from your investment accounts to pay all your bills each month.
There are several popular “retirement withdrawal strategies“, as this method is called. One of the most common methods is withdrawing 4% each year from your investment accounts.
Another method, which came because popular of the two huge bear markets in the first 2000 decade withdraws around 2% a year.
There are several other retirement withdrawal strategies that are based on the performance of the financial markets or investment portfolio performance. All these methods are based on spending the money in your investment accounts to fund your lifestyle expenses.
While retirement withdrawal strategies are referred to retirement income strategies, they are really just spending your savings and the income and growth that’s occurred over the years.
Assumptions About Your Retirement Investment Account
There are some basic assumptions about using the withdrawal strategy to live off your investments. (Assumptions make me a little nervous.)
1. The investment withdrawal strategy assumes your investment accounts will appreciate over the time you are withdrawing from them.
2. It further assumes your withdrawals will be less than the increase in value of your portfolio for at least most years.
3. It also assumes your investment accounts will be earning at least some level of income from dividends or interest. These are valid assumptions, especially for very long periods of time.
You’ll want to personally confirm, well before retirement, that this strategy will work work for you. Do the math. Use a calculator. It’s your lifestyle that you’re needing to support for life.
Read my related post How Much Money Do You Need to Live Off Investments?
Here’s my video on how retirement withdrawal strategies work.
Good Things About the Investment Withdrawal Strategy
Withdrawing money is simple. There is no work involved beyond the usual wealth management tasks of tracking your money, choosing investments funds or hiring and evaluating financial advisors, taxes and banking.
Disadvantages of Retirement Withdrawal Strategies
This is my least favorite method for living off investments. Below I’ll explain the reasons.
Withdrawing from Investment Accounts During Bear Markets
A big problem with most retirement investment withdrawal strategies is that you will probably need to sell securities at or near multi year low prices during bear markets.
This is because the average bear market lasts for about fifteen months. Here is an excellent chart of the history of bear stock markets.
The early 2000 bear market lasted 2.1 years. If you’re withdrawing money monthly, you’ll either need to sell securities during the market lows or have enough money in cash to outlast the bear market.
Note that some financial advisors suggest having up to two years of living expenses in cash type of investments to avoid having to sell during bear markets. This makes sense since the longest bear market in the early 1930’s lasted 2.8 years.
As you can see, the withdrawal strategy involves some analysis and insights.
This strategy can be done be an individual investor willing and able to take the time to understand it. Alternatively, a good strategic financial advisor or financial planner can help navigate the inevitable bear markets when you plan to live off investments.
You can read more in my post How Will a Stock Market Crash Affect You?
Fortunately, bull (rising) stock markets are much more common than bear (falling) markets!
Building Wealth Tip – While there is a very popular video that explains how everything you need to know about investing can be explained on a cocktail sized paper napkin, after almost 40 years of investing, I question this theory.
The Withdrawal Strategy Fuels Scarcity and Lack
What we believe deep inside affects our actions. Most people feel some guilt or remorse about withdrawing from their investment accounts to pay for their living expenses unless they have extremely high net worth.
Even those with very high net worth have grown their spending to match their level of wealth. This means that spending savings is not always easy even for those with plenty of funds for life.
Most of us are conditioned our entire lives to save money and put it into our investment accounts. Suddenly, in the last half of our adult life we’re supposed to feel good about spending this money.
How can you really justify that long awaited cruise expense when, deep down, it feels wrong to spend money you may need for paying the electric bill one day?
Economics, Financial Markets and Politicians
Simply put, what if your math is wrong with the withdrawal strategy due to factors way beyond your control? The downside is huge! No one wants to run out of money.
What if there is another 57% drop in the S&P 500 index stocks shortly before or after you retire which completely derails your retirement plans?
Or what if there is a larger number of bear markets than usual during the period you plan to live off your investments?
These potential threats are not mentioned here to induce financial fear, an unhealthy emotion when it comes to your money. They are here to simply suggest using past data to realistically plan your future, along with having a Plan B.
Financial independence and retiring early is wildly popular now, especially among those who have not yet experienced severe bear markets as adults with stock market investments.
As we headed into late midlife with conversations about living off investments, the tech bust annihilated the Nasdaq. This was followed by the nasty bear market of 2008 only a few years later. Let’s don’t forget the accompanying horrible recession and enormous drop in the value of real estate.
Our conversation changed to Plan B of creating alternative income streams. Fortunately, after quite a lot of tweaking, we are loving Plan B. It has given us opportunities we never even considered as possibilities.
You can get my eBook here with our top 9 wealth building and income generating strategies.
(Ever noticed how our biggest growth opportunities usually stem from our biggest challenges?)
2. How to Live Off Investments with Income Streams
With the income streams method of living off investments, income generating investments are made so that the cost of living is covered from this income.
Ideally, no withdrawals from savings must be made with this strategy.
To explain further, you have probably noticed that dividends received from owning stocks or stock funds are usually automatically reinvested? With the income stream method, you would choose to have the dividends not reinvested.
This money could then be used to pay bills.
Similarly, you’d also use the income from bonds or bond funds.
With this method, the primary goal for investments is to generate income.
Sometimes when an investor buys an undervalued income generating investment, it will often increase in value, also. This happens most often after a big, bad bear market when stocks are selling cheaply.
Buying stocks after a bear market is an excellent wealth building strategy that can greatly enhance the income stream strategy for living off investments. I write more about it in my post How to Build Wealth.
Example Using Interest Off 2 Million Dollars to Live Off Investments
Here is an oversimplified example of the income stream method to live off investments.
Interest off 2 million dollars in longer term bonds paying 4% is about $80,000 a year before taxes. (Again, there are many variables with taxes, so I won’t address them here.) This equates to $6,667 per month.
If this amount covers the investor’s lifestyle expenses, bond income could be all that is needed to live off investments without spending investment savings.
This is a simple example, especially since most people would have the 2 million dollars in both stocks and bonds with the intention that growth would occur with the stock investments.
And many investors with a net worth of over 2 million dollars have alternative investments that allow them to increase income while living off investments.
Read my related post The Best Income Stream to Start Before Retirement.
Here’s my related video on Retirement Income Planning that takes you step by step through this process.
Alternative Investments to Live Off Investments
Here is an important, beneficial element that most retirees and people living off their investments are missing: Alternative generating assets can be used in addition to traditional stocks and bonds to significantly increase investment income.
Mainstream retirement plans usually only consider traditional stock and bond investments.
Read my related post How Many Income Streams Should You Have?
Benefits of Alternative Assets When Living Off Investments
There are many benefits from alternative investments as addressed below.
Diversification Lowers Investment Risk
Another reason many people seek alternative investments is because they don’t want their entire life savings tied up in traditional stocks and bonds. Alternative investments add another layer of diversification to an investor’s portfolio.
This may include lead investors to slightly alternative investments such as REITs and MLPs. It may also include non stock alternative investments, such as real estate or small business.
Read my related post Start a Business or Invest in Stocks: Which Is Better?
Higher Yields from Alternative Investments
More unique alternative investments, such as real estate and small business, often generate higher income yields. They frequently have tax advantages, too. And they often provide residual income.
Living off investments can be completely passive. But many people enjoy at least some mental stimulation in retirement beyond cross word puzzles! Many alternative investments involve more work than simply collecting dividends, fulfilling that need for a little part time work.
Wealth Building While Living Off Investments
One huge benefit of non stock investments is that those investments can increase in value significantly over the years while also paying out good income.
This is true for real estate rental properties as well as online businesses. Even bloggers and small home based online businesses are selling their businesses for well into the millions.
This essentially allows retirees who are living off investments to take advantage of the income generated from their assets while also building wealth.
Not everyone will want to explore beyond simple stock and bond investments but alternative investments can enable retirees to live off investments who would have otherwise needed to spend their retirement savings with withdrawals.
The type of assets selected for living off investments will depend on the amount of income needed, the skills and interests of the investor, and the amount of capital the investor has. Every investor has to choose what works best for his own situation and desired lifestyle.
Read more about this in my related post How to Buy Assets That Generate Income.
How to Live Off Investments by Combining Investment Withdrawals with Income Streams
This method of living off investments combines the two methods above. It assumes that the investor has enough investment savings to generate enough income to cover most if not all living expenses and can also rely on retirement withdrawals when needed.
The combination method of living off investments has several advantages addressed below.
The combined income streams method gives the investor the opportunity to stay invested in growth assets. Growth may come from stocks, real estate or small business. Bonds can even increase in value when purchased strategically.
As mentioned, you may also be able to take advantage of tax benefits from alternative investments.
This strategy has a lot of flexibility to accommodate you if you want to have more, or less, passive income as you age, or when life plans change.
It allows you to keep steady income streams during bear stock markets and make minimal withdrawals than an investor without extra income streams.
The combination method also provides a great amount of diversification between traditional financial markets of stocks and bonds, and nontraditional investments.
Diversification accomplished in this way reduces the risk of losing all your income, and seeing a decline in net worth during bear markets. It’s a simple risk management strategy.
Financial independence is knowing how to live off your investments and doing it. As you can see, there are three main methods to accomplish this which all focus on getting funds from investing.
Again, you either spend your savings, spend the income your savings generate, or do a combination of the two.
Everyone must do what works for them in their pursuit to figuring out how to live off investments, the ultimate financial independence.
In late midlife we began to create multiple income streams after seeing the benefits over withdrawing savings to live in retirement.
Updated: July 18, 2019
First Trust Portfolios L.P.