YOUR MONEY: How to live off your investments

Last week a reader asked how much he’d need to save before he could resign and focus full time on investing, and whether he should start off by investing in exchange traded funds (ETFs) to bulk up his capital. The reader is in his mid-30s, with no spouse or children. We had two responses to his question:

Answer 1 

I would think that, as a bare minimum, you would need to replace your current income with trading income. You would in all probability struggle to earn more than 10% real return per year. If you manage to earn that high a real return, it means your capital needs to be 10 times the required income (to earn 10%). And if you make 10% real return a year and withdraw all of that to live, your real portfolio value will stagnate.

So, a far better idea is to continue to work and earn income. Add savings from your salary to your portfolio. Not only will your portfolio grow, you will also see what real returns you achieve over time. There will be good years, easily surpassing a 10% real return, but there will be years when you might be down 20% or more. See what you can realistically achieve over at least  five years before venturing full time into trading.

- Theo R 

Answer 2 

First, you ask how much you should save every month. The answer is: as much as possible, as every extra rand saved will get you to your goal that little bit quicker. But the other side of the saving equation is how much you spend. Focus on your spending as well, and on where you can cut costs, because every rand not spent can be saved. Then, as you’re spending less, you’ll need less money for when you live exclusively off your investments.

The question of how much you will need to be able to quit your job and live off the investments is the same one asked by many retirees. The answer is that you need about  25 times your annual spending. So if you need R250,000 a year you need a portfolio value of R6.25m. This would let you take out your required R250,000 a year and the portfolio would still be growing and keeping track with inflation.

This assumes that your portfolio grows at inflation plus 4% a year, which is not the hardest achievement. It brings us to the returns possible. Let’s assume an annual inflation rate is right in the middle of the Reserve Bank’s target range, at 4.5%. Using the above example, you’d need to grow your portfolio by 8.5% a year (the 4% you take out every year plus inflation).

But if you could sustain, say, growth of 11% a year, after inflation your portfolio will be growing at 6.5% and you could take that money out every year to live off, which would, in other words,  be just over R400,000, and more than you need.

If you’re able to do 11% a year in growth and only need R250,000 a year to live, instead of the R6.25m you’d only need about R3.8m. Using the above, you will in theory leave behind a substantive estate. If you’d rather not, you can decide what you think your life expectancy would be and reduce the required amount even further. But this carries huge risk, as, frankly, we have no real idea how long we’ll live.

Lastly, you ask if putting it into ETFs  as you learn is a good idea, and the answer is yes. They’re cheap, and an easy way to generate market returns.

- Simon Brown: Just One Lap 

We’d like to hear from you on this topic. E-mail us on yourmoney@fm.co.za