You know you’ve made it when you can live off your money’s interest. You have so much money you don’t use that others pay you to borrow it. You do nothing and earn enough to never have to work again.
Not only that, but none of your future generations will ever have to work either. If you keep reinvesting in this miracle, you can take better care of those you love or increase your lifestyle.
Sounds too easy to be true? It’s certainly not simple math. In an always-changing world, very few firms can guarantee you consistency, whether you buy bonds or index funds. and the more you lend, the more careful you need to be with who you trust.
Besides, interest-only retirement is one of the slowest ways to progress financially. It may not make sense unless you invest in something with more upside potential: a business, some stocks, maybe real estate.
If you ever dreamed of financial freedom, living off your interest is the closest reality to that dream. Although it’s possible, there are some difficulties to realize it.
- Can You Live Off Interest?
- What You Need to Know About Interest-only Retirement
- The Fastest Way to Live Off Interest
- When Will I Live Off Interest?
Can You Live Off Interest?
It’s a common belief that you need dozens of millions of dollars to retire with interest only. But it doesn’t need to be that much, because it’s all about how you spend and how much you reinvest.
Assuming you want a good life (not extravagant) with no expensive hobbies (e.g., yacht racing, collecting sports cars…), you’re good with $100K per year in expenses at most. Aside from big purchases, anything extra will likely be unessential and contribute very little to your happiness.
Now, the lowest the interest rate is, the more likely it is to last long. Let’s consider a 4% annual return. How much do you need to generate $100K? $2.5 million. At a 5% interest, it’s $2 million. At 6%, it’s about $1.7 million.
That’s the minimum you save for simple interest after you pay taxes and deductions.
Most people stop the reasoning here. “That’s it! I’m only a few millions away from being financially free.” But things are a bit more complicated than they seem.
What You Need to Know About Interest-only Retirement
You don’t want to get to your golden years only to find out that you did the math wrong. So to avoid unrealistic expectations, let’s introduce the real-world challenges.
Let’s address the elephant first…
Every year, your money is worthless and less. And the more you save, the more noticeable this gap is.
For simplicity, the annual inflation rate will be 1.5%. That’s what you need to deduct from your interest yield. Given that most rates are between 3% and 6%, a 1.5% decrease is like losing 25% to 50% of your interest rate. It takes you twice as long to generate $100K unless you invest twice as much.
That’s why simple interest is a terrible idea. Invest a bit more and do compound interest instead. If inflation grows linearly and your funds grow exponentially, you will become wealthy.
But first, you need to earn that initial amount.
High entry barrier
Not everybody that walks on the street has a couple million in their pockets. It takes patience to earn your first million, and it takes even more not to touch it for so many years.
If you choose compound interest, it’s ideal to reinvest 10-25% of annual returns back into the account. This way, you don’t need to wait until you cross $2 or $3 million. You could start with $300K at compound interest and leverage to $2-$3 million in 3-10 years.
If that’s all your savings, it takes a lot of discipline to put that aside and stay broke until it generates returns. It’s not that effective for those aspiring for wealth, only for the rich who want to maintain existing wealth.
It’s human nature to underestimate the obstacles and overlook our future success. You will likely have to spend big bucks on something you didn’t expect at some point:
- The car breaks, or your insurance company raises the rates
- The business needs extra funding
- A few employees left unexpectedly
- Your relative is in the hospital and needs financial help to survive
- Your investment firm underperforms
- Your borrower delays in repaying the amount
The “whirlwind of life uncertainties” can quickly erode your fortune if you don’t prepare for it. If you don’t have an emergency fund, reserve some of your investment returns for the unexpected. That means:
a. You have to save a few hundred thousand more
b. You have to get a higher interest rate (at least 0.5% more)
There is always the chance you lose money even in the safest bets. If you want to protect yourself from a loss, you need to do extra research on other assets you can use to diversify.
As you add more streams, one will inevitably be more effective than another.
Let’s say that you keep all in one asset, and your chance of losing it is 2%. Imagine you distribute it among 10 assets, and each has a different risk, some of which could be 5%.
Your risk of losing increases slightly, but you’d only be losing one-tenth of your earnings. Keep in mind:
- You’re neither protected if you put all your eggs in one basket
- When you increase your risk tolerance, your rewards/returns increase too
The profit difference may not be a lot, but diversification makes your investment portfolio more stable.
Although it can be very stable, it’s the slowest vehicle you can use for wealth. Only 3 to 6% grows per YEAR and anything that claims more than that is either fraudulent or won’t last long.
Lower rates mean you need to put more money on your principal. If you don’t have any big plans and want to retire, you can do it, no problem. But if you’d like to earn more for whatever reason, you need to find a better investment vehicle or business.
Imagine you had $10,000 and wanted to make a million with interest only. The idea is to put down $10,000 and reinvest the interest until it makes $1 million. But wouldn’t it be faster if you invested $10,000 on something riskier? That’s enough money to start two businesses.
If you want to live off $100K per year only from interest, you need a good reason to justify not touching the millions you invested. And let’s not forget the opportunity cost: how much money and time have you lost by not investing in a fast-growing asset instead?
Would you rather get a million dollars or a chunk of it every month? If you don’t have that patience, you shouldn’t probably do interest for now.
The Fastest Way to Live Off Interest
Despite the downsides, interest-only retirement has undebatable benefits, which makes it a worthy goal for everyone. So what’s stopping you from living that life? A million dollars?
One (unrealistic but simple) way is to borrow a couple of million dollars from your bank at low interest or none. You put that on compound interest and let the amount grow. If your ROI is higher than your minimum payments, you’ll profit enough to return the amount later. You borrow $1M, make $2M, and return $1M.
Any bank offering such a deal is either a scam or very selective. Here are some simpler ways to get there faster:
Fund your retirement account
Your biggest benefit is tax-deferred dollars. When you contribute to a Roth IRA or traditional 401K, you’re deciding when to pay taxes. For example:
- You can delay taxes so that you have more money to compound today. And once it grows tomorrow, you pay all the tax.
- You can pay taxes right away as usual. You’ll have less money for the fund, but all the interest you get from now on is tax-free (unless you withdraw before you’re 59 1/2)
With a traditional 401K, you compound interest faster but pay more tax. With Roth IRAs, you get more ROI but it grows slower.
Regardless of your wealth plan, ALWAYS take advantage of tax privileges.
Your retirement account can be anything you want, from the super-safe US Treasury Bonds to the most volatile stocks, or a bit of everything. Here, you can learn more about the types of investments.
Diversify your investments to manage risk
Here are the most well-known rules of investing:
- Diversify to reduce risk
- Don’t lose money. Invest as much as you can afford to lose
- Invest in what you know
You can keep most of your money in bonds or index funds to keep it safe. And to speed things up, you can allocate 10%-25% on riskier investments. This way, you can earn more, and if you lose, it isn’t a lot (you almost never lose 100% of your funds).
It’s not about gambling with that money, but you can use it for short-term market opportunities. And as long as you hold your investments for twelve months, you don’t pay any tax in capital gains.
Also, the risk you take should be proportional to your income to get the best return.
a. A business or investment costs $5,000 to start, can become profitable in three months, and has millions of profit in upside potential. But the chance of success is 35%
b. An investment allows you to get a 1% return every month at a 99% success chance
If you earn $10K every month, you’ll make far more money if you invest in A instead of B.
You may lose $10K, $20K, $30K, but then earn millions of dollars. Because the downside is only $5K, the risk is worth it.
When should you invest in B? At least, you keep investing in A until you earn enough to match your income level with B:
If 1% were $10K per month, 100% would be $1M. You keep investing in A until you rack up a million, then you invest it in B. You can quit your job, or you can keep investing in A with your income.
Lower your risk as your fortune grows.
Of course, there are a million paths to make a million dollars. You can learn more in a guide we wrote on how to turn $100K into $1M fast at low-risk.
Set financial habits that will accelerate wealth
If you commit to it, living off interest may take less time to achieve than you think:
- Choose compound interest, not simple
- Dedicate to personal accounting to prevent fraud and track expenses
- Lower your expenses with a simple lifestyle. Get rid of expensive, bad habits
- Reinvest your profits back into the principal. Keep reserving part of your income for reinvesting
- Research and take action to minimize taxes, such as moving to the right state
- Educate yourself and others about securities fraud, so that you don’t lose your money on get-rich-quick schemes
- Adapt your risk tolerance to the amount of money you’re risking
- Stay away from debt so that you don’t slow down your finances
- Improve your credit score to get better credit cards and discounts on big purchases
Use most of your money instead of saving it
It’s safe to say that, at least, 1% of your annual income will go for unexpected expenses. Let’s include an inflation rate of 1.4% per year. So it’s a minimum of 2.4% per year lost or 0.2% per month.
It may be nothing, but what if you keep $1M at the bank at no interest? It’s costing you ~$2,000 per month. And $10M? $20K.
How do you avoid this loss?
a. You save less money to scale down your losses (only save for your emergency fund and living expenses)
b. You get rid of all that money and invest it somewhere where your monthly return beat the 0.2% loss (an easy task)
That’s why it’s smart to “stay broke” when making millions. It also lowers your tax bracket and allows you to withdraw more money long term.
Literally, any investment is better than storing cash. And for lifestyle purchases, think first of all the maintenance costs (and time) required.
When Will I Live Off Interest?
It depends on your wealth strategy. Do you prefer to work on a job for decades, wait for ages to compound interest, or are you willing to accept more risk to speed things up?
Even with a perfect retirement plan set up, you can’t enjoy the money until you’re 59 1/2. If you want to retire early:
- Maximize your active income streams
- Create semi-passive streams (businesses) and scale beyond six figures
- Invest most of the unused money based on your research and risk-reward preference (compound interest mandatory)
It’s not that hard, and it lasts forever. Imagine if your past generations created this system.