0% return… but paid for!
Unless you have millions, of course. Then the returns still matter, but not so much, you can live quite well on what your millions make on a 3% savings account. I was checking my net worth the other day, and realized my investments give me a monthly return just over 1%. That is the almost certain part, like rental income. Having three different tenants, and one of the nicest flatshares in a UK college/university town, I am fairly confident my rooms will have a high occupancy rate. Over four years of ownership, I have had one empty room for one week, all the other tenants moved in the day after the previous left. So I consider this fairly stable passive income, if real estate can be considered passive. I do not include returns from riskier investments in that 1%, as those are never guaranteed until they are in your bank account.
How much do you need?
I do not have a budget, so I spend what I need to spend each month, but life is cheap in Guatemala so that is rarely more than $700 per month, handyman included, since my little house is fully paid for.
Add to that a month in Europe every year at $2,500, i.e. an additional $2,100 (I still pay the handyman and a few bills while away) to the yearly budget, and another $1,500 trip somewhere else, you get to $1,000 per month. This is for basic living expenses and leisure, not for investing or savings, which is why I am targeting an income of $5,000 or more. At the moment, I have 5 full time staff working on my 90 acre land development plus some extras here and there, have put more than $20,000 in house repairs and construction since last October, bought a car, a boat, etc.
Also, my goal is to not have to go back to a cubicle, so $1,000 may do the trick today, but I may need $2,000 tomorrow, or see an investment go wrong and some sources of income dry up. Better safe than sorry, even more so considering I do not have an emergency fund.
You may need more or less, the important thing is defining how much money you need in the bank to sustain your lifestyle.
How much capital do you need?
At the 4% safe rate of withdrawal, I would need $300,000 to generate a $12,000 income per year. Or $1.5M to generate $5,000 per month. Building a nest egg that will allow you to maintain your lifestyle at 4% is not easy for everyone. According to Census.gov, the median net worth in the US is $68,800. It goes up to $240,800 for people with a graduate degree, and as low as $972 for a female householder under 35. With a $68,800 net worth, I would need an annual return of 17.4% to sustain my $1,000/month lifestyle. At 4%, I would only have $230 to live every month. You can see that the rate of return makes a big difference on the overall capital you will need to live off your wealth.
Take my cattle for example. It brought me a 38% return per year while it lasted. That was an exceptional investment, and it is unfortunately over. But if I had a way to keep the cattle forever, I would need to invest only $31,600 to cover my $1,000/month expenses.
At the 1% return I am currently getting, $100,000 would be enough to be financially independent. I know I am omitting inflation but I am just trying to prove a point. $100,000 is a pretty low number, and part of that would be my house, which is not bringing any income, although if you own a nice little $80,000 house in the Midwest, that number could be $150-$200K. Still far from the million and then some that people consider to be their magic retirement number.
$1,000,000 in the bank will never give you 1% per month. A “high interest” savings account may give you 2 or 3% annually at the moment which is barely enough to keep up with inflation while generating $1,000/month in passive income.
Now I hear you say “Guatemala is a cheap country, you were able to buy a house cash, and you get high returns by taking high risks”. True. So I have an all American, real life example for you. Paula over at Afford Anything bought a $21,000 3 bedroom foreclosure, brought its price up to $30K with repairs and rented it for $900/month. Her return after taxes, maintenance and so on is around 18% per year. A couple more houses at the same price mean you invest $90K and get $16,200 per year in rental income. After two years, if you saved that income, you can buy another house. And so on.
You can do it too
Generating more than market rate is possible for most people with a little cash who are willing to take risks. Paula’s tenants can disappear overnight, or stop paying rent for a few months and leave the place in dire need of repairs, eating up the profit. Stock plummets, companies go bankrupt, inflation gets in the way.
But with several sources of income, and a balanced portfolio that includes both risky investments and a few safe ones, you may realize that financial independence isn’t as far away as you originally thought.
Have you ever calculated your rate of return over your net worth? What do you do to get the best returns possible?
This post was featured in A Young Pro, The Carnival of Wealth, Outlier Model, Financial Uproar, Budget Blonde, thank you!
I’ve never looked at our ROR of our net worth, but it would be interesting to do so. We could do better at diversifying since most of our money is in target date funds in our retirement accounts, an index fund and some stocks in our personal account and our home. I’ll have to head over to Mint and see if I can come up with our ROR.
I used to have 5 index funds, one of which was Asia-Pacific and had good growth potential. You can stay with your investment streams and diversify within them as well.
With my current net worth I’d probably need like 20% return to live off my wealth perpetually, which is not really sustainable. Some of my investments like my farm is returning over 20% every year but that’s probably not going to last forever. You bring up an interesting way to track our finances. As long as we have a positive net worth we can just try to push this number down until we eventually reach 4%, by which time we’ll be financially independent 🙂 peace of cake. I diversify my investments like millionaires do in hopes to make the same kind of returns that they do 😀
20% is a bit ambitious indeed, I am targeting 30% NW increase this year and that is plan crazy, but dreaming is free!
Great job crunching the numbers! It all boils down to how much you are willing to save *and* invest prudently.
I wouldn’t gamble my grocery money but anything on top of basic expenses I am ready to try and get the best return from.
“Paula over at Afford Anything bought a $21,000 3 bedroom foreclosure, brought its price up to $30K with repairs and rented it for $900/month. Her return after taxes, maintenance and so on is around 18% per year.” That’s amazing! There seems to always be opportunities if you are diligent and willing to look for them.
With foreclosures in the US you can find lots of great deals, some places seem to have better ones than other but I know a few bloggers who do great with distressed property. Dominique from Your Finances Simplified is another example.
We’re currently looking for more investment opportunities to continue to diversify, but prices have gone up pretty dramatically (bouncing back from the bottom) here over the past couple of years, so cash flow is tougher to find. One of the things we’re trying to explore is buying/funding small businesses that generate enough income to have a manager paid for and wouldn’t require a whole lot of our time and effort.
In Europe, automatic laundries are pretty good semi automated businesses but I guess in the US everyone has a washing machine at home. Small businesses are good ideas if you totally trust the manager, a sneaky one could eat up all the profits.
Will you be staying in Guatemala? The amount you need could change drastically if you decided to live somewhere else.
I have almost 10,000 invested and my return rate is not amazing so I will be carefully calculating how to draw down my principal and not run out of money before I die.
I am planning on staying at the moment, but could live off passive income in Paris too. At the moment the surplus is invested but I know there may be less surplus in a more expensive place.
Your last point about balance is great. I think it’s only prudent to know your options when looking at investment opportunities, but I also think it can be dangerous to chase high returns. That kind of mindset has gotten a lot of people into trouble. It’s very true that, with certain rare exceptions, higher returns come at the expense of greater risk, and that risk is very real. Exceptional returns are possible, but a diligent approach to saving, diversifying and controlling expenses is one that is much more realistic for most people to control.
I have a few high risk investments, but my house is paid for and my basic expenses are covered by safe income, so I can afford to lose that money. Taking the risk from the real estate example is not so risky yet the returns are high, it all depends on your risk tolerance but a little risk can accelerate things greatly.
Generally speaking, I don’t obsess over net worth or safe withdrawal rate at all. What matters to me is how much income my investments are producing. Once the cash flow produced by my dividend growth stocks covers all of my basic expenses, I’m financially independent.
This isn’t to say that I’m not interested in capital appreciation or total returns, but I feel that if you pick the right stocks, you can get both income and returns.
I am not familiar with dividend stocks, but I understand the dividend can vary from one year to the other, so you would need to have some kind of safety cushion to ensure they will always cover your expenses right?
I think of varying levels of protection. There is the barebones level of FI, with no cushion, but where I no longer need my job. Then there are various levels of cushions above that depending on the lifestyle I want to lead. Since I’m not planning on retiring or becoming an entrepreneur post-FI, the cushion will just keep building up over time.
I love your last point Pauline, about it coming down to several sources of income. That really is diversification at it’s best, finding streams that are diverse and can shield you if things sway one way or another.
the topic of my new site 🙂
No returns are guaranteed, but historically the higher returns are riskier. I think of myself as a long term investor and look for growth. I used to own income property where cash flow was important, but increasing value was more important. Eventually, I cashed out and did rather well. I now that money invested in the stock market and look atlong term growth as an objective.
Great point about increasing the value of a property, although that is not a sure thing, when rent can come every month to offset the running costs. Tough decision between the two, unless you can easily afford repayments and to wait until the price is right to sell.
Thank you for mentioning me! I love that you’ve got a paid-for house, you’re investing, and you’re building a life that will prevent you from ever needing to go back to a cubicle …. me too, and it’s pretty wonderful! I’m glad you’re spreading the anti-cubicle message. 🙂
Some days I think we should keep quiet or everyone would leave their cubicles and we may have to go back and staff them!
This is a great way to look at things! Thanks Pauline!
I’m always doing these types of calculations, probably more often than I should 🙂
Rate of return of overall net worth can make a huge difference in terms of one’s future lifestyle. I’m slowly getting a bit more conservative as the years go by, but can’t get too risk-averse. Anyway, simply running the numbers and different scenarios can make the power of rate of return and compounding very evident.
haha, it gets addictive! I am not a number nerd but when it comes to money I can spend hours on a spreadsheet.
I don’t really need that much to get by. Grenada is pretty expensive to live in. Since they’ve had American students here for the past 35 years, they’ve successfully jacked up all the food and housing prices. Still we don’t spend that much, and we’re focusing a lot more on saving for the future. 🙂
I was talking to our neighbour up the road today who is 84. I took that opportunity to ask him questions about personal finance and what he did right and any regrets. The one thing he regrets is not being able to put more money into his RRSP as it was only $2k allowable at the time he said. Other than that he says him and his wife are living the high life and aren’t even using their pensions only money from an annuity which they rolled over. He also said he made the most money in his time not from the stock market which he said you win some and you lose some but rather from real estate. He said the real estate market is where the money is at and believes it always will be. We talked more but it was interesting to learn from someone who’s been there, done that, retired and living it….
yes, it is always nice to ask people about their path, mistakes and accomplishment. Old people are often shy and afraid to be boring but if you ask questions you can learn a lot.
Very interesting. I’ve never performed this calculation, which is odd because I perform almost any financial calculation!
It is really eye opening to see how people can live on a small amount of income per month and be “retired”. Our culture has transformed every want into a need and now people think there is no way they could retire and live on $2-3K per month.
I just read this post about how Andy lives on $1,000/month in Kansas City http://tightfistedmiser.com/2013/05/09/2013-sample-1000-monthly-budget/
Compared to that my budget with staff and travel seems ostentatious.
There are plenty of examples of people living on less, I like to think that my behavior is at least not wasteful. I don’t buy things I don’t need, try not to throw food away, etc.
We are learning to live with a lot less because we love our life style. There is no way we can return to bosses, coworkers and 9-5. We will continue to lower our expenses, pay off debts, and find new revenue streams because going back would be catastrophic for us.
This is an awesome feeling when you realize you need so little you don’t have to worry too much about money, because you can do without a lot of useless things.
The bond index fund that I currently have has an annual yield of 4%, which would be enough to more than support our lifestyle. However, bonds only make up about 10% of our portfolio, because we aren’t ready to retire just yet. I’m READY to retire, we just don’t have the capital to do it. We just bought a second house for fairly cheap, so we’re going to have an income property, and probably try to buy a 3rd one with the profits in the near future.
That sounds awesome! I would have more faith in rental returns than the stock market, I don’t feel really safe with virtual things. At least a roof is a roof and people will always need a home.
I LOVE your super-creative investments 🙂 Like you said, it’s all about the return (traded off with the risk.) We just paid off the house and have a few more things to pay off (ie house loan from parents), until we can start piling our cash into awesome things.
Happy to feature you anytime! 🙂
I came across this blog and I find it extremely interesting. As a working women, rather than trusting only stock market I have more faith in these rental returns. Definitely, I would go for an SMSF with a strong SMSF Investment Strategy. It feels really safe when you need to invest so little and don’t worry about the money at all even after the retirement. Awesome Blog, Awesome Information, Keep up the good work!