If you work in an industry that produces big fortunes in small doses (producer, writer, entrepreneur, etc.), you may reach a point early in your life where you could start living off your investment portfolio long before the word “retirement” even crosses your mind. So how much can you take out and when can you start?
The 3% Spending Rule
In my previous blog, Long-term Saving for the Short-term Worker, I wrote about Scott, a TV writer and producer who wants to create a better system for saving more during his high-earning years. But before he does that, he has agreed with me that he needs to figure out what a “minimum lifestyle” means to him. This amount will dictate how much he needs to have saved up so his nest egg can provide him with a base level of recurring and stable income. He can then continue to work on his next TV pilot (or any other project) without having to rely on its success for survival.
Pre-Retirement Income
How much can a person draw from a portfolio annually if he starts well before “retirement age” (i.e. the 60s)? Perhaps you’ve heard of the infamous “4% withdrawal rate” which refers to how much a retired person can draw from their portfolio. Here’s a quick refresher: You reach your 60s, multiply your nest egg by 4% at that time, and use that number as your spending allowance for the rest of your life. Got $2 million at age 65? Then you can plan to withdraw roughly $80,000 annually forever (plus annual cost of living adjustments). If the person doesn’t panic during a market correction (by moving his portfolio to cash), the odds are quite high that he’ll still have some money in the nest egg at age 100.
But Scott wants to use his portfolio to cover his basic needs before he turns 50, so my suggestion is that he drop that 4% rule down to 3%. Why? Most of his withdrawals will be made up of actual portfolio income (dividends from stocks, interest from bonds). Since a very small portion of his cash flow needs, if any, will come from his appreciation, his portfolio should have no trouble maintaining its value over the long-term, even after factoring inflation. While the 4% rule relates to how long a person will need the nest egg to survive, the 3% rule doesn’t. Now what Scott needs to do is determine his minimum lifestyle figure.
Setting His Minimum Lifestyle Number
Scott estimates that he can cover his personal needs in Los Angeles with about $100,000 of annual cash flow. To support this, he’ll need just over $3.3 million (in today’s dollars). Does this mean he’ll stop working once he gets there? Heck no! He still has other goals on his radar and loves the idea of enhancing his personal life in the years where his income is high (who wouldn’t want to celebrate a bit after getting a TV show renewed for a couple more years!?). He also wants to save for a nicer home and private school for his kids.
This means he has one final task. He needs to set some rules for how much more he can spend in his high-earning years, how much he’ll set aside for the big-ticket items (nicer house, kids’ college), and how much he needs to put into the bucket that will ultimately fund his minimum lifestyle requirements. Stay tuned for my next blog where I address my 1/3 Rule.
Happy planning,
Barrett