Million Dollar Retirement
One of the questions people often ask is that whether they can retire on a million dollars. In this article, we are going to discussion how much income you can expect in a million dollar retirement.
First of all, congratulations to you if you are one of those fortunate ones who amassed a million dollars in your nest egg. It is a very big milestone to most of us.
But, are you truly financially independent? What kind of lifestyle can you live with a million dollars in your retirement? You don’t want to run out of money, right? The lifestyle that you can afford highly depends on how much income your portfolio produces. Let’s go through a few scenarios here.
Savings and CDs
Savings account and CDs (certificate of deposits) are probably one of the lowest risks investments. As of today (June 2017), yield of a 1-year, 3-year and 5-year CD is about 1.5%, 2.0% and 2.35% respectively according to BankRate.com. That gives $23,500 a year or roughly $2000 a month if you put your money into a 5-year CD. However, your purchase power will be eroded over time due to inflation.
US government offers Treasury Inflation Protected Securities (TIPS) with different maturity dates. You can buy TIPS directly from US Treasury, a broker or a bank. TIPS pay interests every 6 months and the interest rate is a fixed rate determined at the auction. Treasury adjusts the principal according to the consumer price index. The interest rates of the recently issued TIPS may not be as good as those issued in the late 1990s. For example, the TIPS issued in April 1999 offers interest rate of 3.875% . It is not bad at all receiving $3229 a month risk-free inflation protected money, assuming our government will never default.
If you are looking for higher yield than CDs and TIPS but do not want to take excessive risks, you may consider buying high quality muni bonds and corporate bonds. Bonds are essentially loans to municipals and corporations. In return, you are receiving monthly payments. Even though muni bonds are perceived to be safe, it is not impossible for municipals to bankrupt. Orange county’s 1994 bankruptcy was a wakeup call to many investors.
Corporate bonds usually carry higher interest rates because the risk to default is higher. It is utterly important to check their credit ratings before making a decision.
There is a very wide range of yield and coupon rates from both muni and corporate bonds. For high quality bonds, for example with credit rating AAA/Aaa, expect the yield to be less than 1%. For BBB rated bonds, you may find yield of 3-4% with a coupon rate of 5%. However, they carry higher risks.
To purchase municipal and corporate bonds, a popular way is to purchase them through brokerages as there are thousands of issuers to choose from.
Fixed income Mutual Funds and ETFs
Buying bonds from a single issuer could be quite risky because if the issuer bankrupts, your hard-earned money will be gone. Mutual fund companies and other financial institutes help you diversify your portfolio. Some mutual funds and ETFs (Exchange Traded Funds) focus on bond portfolio and others may acquire other fixed income investments. For example, ISHARES Core U.S. Aggregate Bond ETF (ticker: AGG) is one of the biggest bond ETFs, with assets over $46B. Their yield is about 2.3% with an expense ratio of 0.05%.
Similar to individual bonds, funds with higher yield are usually riskier. However, investing in diversified fixed income mutual funds and ETFs is still safer than buying individual bonds yourself.
Stock Mutual Funds and ETFs
If you can tolerate higher risk, investing in stock mutual funds and ETFs maybe a good option. According to this article, if you invested in one of these 3 S&P 500 index funds, your 5-Year Annualized Return could be as high as 13%. That is $130,000 annual gain from a million-dollar portfolio.
Be sure to talk to your investment advisor or do your homework before making such investment because you may not be able to tolerate the risk. For example, S&P500 dropped roughly 37% and 22.1% in year 2008 and 2002 respectively according to YCharts.com
If you have time and energy to manage tenants and do most of the repairs, buying investment properties may be a good idea. For example, according to Zillow.com, it is possible to buy a 2-bedroom condominium for $400,000 to $500,000 in San Jose, California. Typical rent is about $2000-2500 a month in 2017. Yield is about 5% before taxes, repairs, depreciation and HOA fees.
The real estate market in the US is very hot at the moment. Some people suggested that we may be in a real estate bubble and price may drop dramatically during the downturn.
On the other hand, if you purchase properties during the correction and hold it for long term, it could be a very worthy investment because real estate prices tend to keep up with inflation.
If you want to own real estate investments but not invested in actively managing them, you may consider buying REITs (Real Estate Investment Trusts). They are similar to mutual funds and ETFs. Some REITs purchase residential properties. Some focus on commercial properties and others may invest in loans. As a REITs investor, you own a fraction of the investment trusts. By law, REITs need to return at least 90% of net income to the investors. REITs could be traded like stocks and ETFs. Comparing to owning individual real estate property, REITs can be easily liquidated if you need cash.
Yield from REITs are usually between 4% – 8% , which is higher than the return from CDs, Muni Bonds and Treasury Bills.
In this article, we touched upon several different kinds of investments for your million dollar retirement and the typical yields from those investments. Hopefully, it helps you figure out the income generating potential from a million dollars. Keep in mind that these are hypothetical scenarios and past performance may not be repeatable. You should use your own judgement and consult professionals on your investment strategy.
In addition, there are many different retirement income sources that you could tap into. If you still need more money to support your lifestyle, it is possible to generate some income from gigs and hobbies. Sometimes, a few changes could save you thousands of retirement dollars easily.