Living off your nest egg?
If you have listened to Dave Ramsey’s radio show or read one of his books, you have probably come across his discussion of living off your nest egg, particularly for this in retirement. He suggests putting money in a good mutual funds that should average a 12% annual return and then take 8% out of that to live off or supplement your income and then the remaining 4% is essentially a cost of living increase to keep up with inflation. Now barring any unexpected lottery wins or similar windfalls, I am far away from retirement; I got curious how this would work out numbers wise. This particularly came to mind after reading a comment on http://allfinancialmatters.com/ discussing some related ideas of Dave Ramsey where someone asked what happens in the years that the stock market does not return 12% since that figure is an average over the long term, particulary if the return for the year was negative.
To make matters simple, I looked at the S&P 500 index for period of 1988 to 2006, which could equate to a nice long retirement for someone. Over that period, the overall index returned 13.44%, not adjusted for dividends. Here is a chart with what would have happened:
Period End Initial Amount Return Amount Spent Left Over
12/30/1988 $100,000 16.61% $8,000 $108,610
12/29/1989 $108,610 31.69% $8,689 $134,340
12/31/1990 $134,340 -3.10% $10,747 $119,428
12/31/1991 $119,428 30.47% $9,554 $146,263
12/31/1992 $146,263 7.62% 11,701 $145,708
12/31/1993 $145,708 10.08% $11,657 $148,738
12/30/1994 $148,738 1.32% 11,899 $138,803
12/29/1995 $138,803 37.58% $11,104 $179,860
12/31/1996 $179,860 22.96% $14,389 $206,768
12/31/1997 $206,768 33.36% $16,541 $259,204
12/31/1998 $259,204 28.58% $20,736 $312,548
12/31/1999 $312,548 21.04% $25,004 $353,304
12/29/2000 $353,304 -9.10% $28,264 $292,889
12/31/2001 $292,889 -11.89% $23,431 $234,634
12/31/2002 $234,634 -22.10% $18,771 $164,009
12/31/2003 $164,009 28.69% $13,121 $197,934
12/31/2004 $197,934 10.88% $15,835 $203,635
12/31/2005 $203,635 4.91% 16,291 $197,344
12/29/2006 $197,344 15.79% $15,788 $212,725
(I don’t know if this table will display right in your browser, but will try to find a better way of displaying it later.) As you can see the person would end up with an extra $112,725 over their initial principal amount and got supplemental income over the period. Can someone live the 8% amount? Nope, to start getting near those figures you need to save up a lot more money (like $40,000 a year if you saved $500,000), but if you could do that, you probably would also be used to a higher lifestyle than even that 8% figure could provide.