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Can I live like a millionaire?

Beer money, champagne taste is a criticism that can be leveled at a few acquaintances of mine – not least a good friend who lives in fine style for the present but reacts like Dracula to sunlight to the word “Pension”.

Recent jousting over our contrasting lifestyles (“You can’t take it with you!” comes his counter jibe) reminded me of research from the Prudential that reckons the average Brit will have earned a million pounds by age 46.1

That’s a great headline, but a million ain’t what it used to be.

According to the research, it would take a man (I’m one of those) 28 years to notch up his millionth pound earned (assuming he earned the average wage for his age, starting at 18).

After 28 years, a million would only be worth around £492,000,2 as inflation gets to work like woodworm on Pinocchio.

Of course, you’ll have to pay the bills along the way that will consume much of your million pound in earnings. Food, water, a roof over your head – even the most extreme frugalists can’t avoid spending a few pennies over the course of nearly three decades.

And then there are taxes.

By the time the average worker has earned their first million pounds they will have paid approximately £138,500 in tax and £99,680 in national insurance – a total of more than £238,000.

Maybe I’ll put that Ferrari catalogue back on the shelf for now.

Making a slow buck

What does a million pounds buy these days?

The real question is what could I do with a million pounds if I had it now? There are plenty of answers to that, but essentially I’d like to live it up, draw an income, and never work again please.

The standard rule of thumb for living off your assets is that you can withdraw 4% a year without going bust.

My million pounds equates to a £40,000 annual income in that instance:

£1,000,000 x 0.04% = £40,000

However retirement researcher Wade Pfau has smashed lumps out of the 4% rule with his data sledgehammer, so let’s use a more cautious 3% to keep us out of harm’s way.

The million pounds now delivers an income of £30,000 a year.

So if you can’t live on less than £30,000 a year then you’re gonna need to be a millionaire by the time you retire3.

A real millionaire.

How to save a million

All you need is the saving ethic of a Swedish tramp, an eye on inflation, the magic of compound interest, and a fair wind for your stock-heavy portfolio.

Well I say that, but although the average Brit may see a million pounds slip through their fingers by age 46, in reality it’s going to be an absolute b’stard for most to become a millionaire.

The key factors are:

If you’ve got nothing in the bank now and we assume a new normal growth rate of 5.5%4 for your portfolio, then you’d need to save around £28,000 per year for 20 years to hit the magic million.

You can use Dinky Town’s investment return calculator to run your own numbers – or check out Monevator’s millionaire calculator.

The problem is that inflation of 2.5% a year will wear down that million to around £600,000 in today’s money. You’d draw an equivalent income of £18,000 per year from that, given a 3% withdrawal rate.

So just how much do we need to put away to earn a real million, given annual growth conditions of 5.5% nominal return and 2.5% inflation?

20 years to save a million

To earn the equivalent of a million pounds in today’s money, we need to invest nearly £46,000 a year for 20 years.

By that point, we’ve amassed around £1,640,000 in nominal terms. That’s just over £1 million in real terms.

Impossible you say? It is for me. So let’s take a more leisurely 30-year route to Millionaire City.

30 years to save a million

Annual investments of just over £13,000 a year would balloon into a million after 30 years, given the same growth and inflation assumptions as above.

But, tragically, a cool million in our hypothetical 2046 will only be worth a very uncool £468,000 in today’s money.

You’ll need over £2m to have the same spending power as a millionaire does now, which means you’d need to invest nearly £28,000 a year to make a real million after 30 years.

So let’s think more optimistically. Thirty years is a long time, who knows what might happen? What if growth was a more normal 7% for a 60:40 portfolio of equities and bonds over that time?

You’d still need to find almost £22,000 a year to achieve the £2m target that would make you the equivalent of a millionaire in today’s money.

My Ferrari catalogue is now burning on the fire because I can’t afford the central heating.

A country estate is something I’d hate

Millionaire status will stay beyond the reach of the average Brit for a long time to come, barring a dose of Weimar inflation. Little wonder just one in 65 of us had achieved millionaire status at the last count, and those mainly due to soaring property prices in the South East.

Even comfortable retirement status looks like a steep climb for many. You’re going to need a pot well into six figures as a minimum. Hitting seven figures, unless you’re rolling in it already, is going to be tough, but it can be done.

You’ve got to save hard, live on less, and work long. Who wants to be a millionaire, eh?

Perhaps I’ll re-read The Investor’s tips on how to live like a billionaire in the meantime.

Take it steady,

The Accumulator

  1. Notwithstanding a raft of exciting caveats, like losing an arm and a leg to taxes. []
  2. Assuming a steady rate of 2.5% p.a. []
  3. Not accounting for taxes or the state pension. []
  4. Nominal return subtracting investment costs of 0.5%. []

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{ 70 comments… add one }
  • 49 dawn September 7, 2016, 9:04 pm

    it is a depressing post i must admit
    worst case, pretend youve got a bad back get a walking stick and live of the benefit system that lot seem to do very well indeed.
    im banking on getting state pension of £8000 pa thats worth £200,000 of investments alone
    that will cover all my living expenses and my portfolio will be my fun money.
    i may finish at 57 ten years before state pension kicks in where ill draw from my aviva pension and cash.
    we just dont know how its all gonna pan out
    but articles like this are demoralising but maybe its the hard truth we need to face
    my lifestyle dosn’t require £30,000 pa anyway so im lucky i dont need to get the million.

  • 50 W Neil September 7, 2016, 10:07 pm

    While some caution with safe withdrawal rates is prudent, emphasis on too low ‘safe withdrawal rates’ (e.g. 3%) may make savers and investors unnecessarily disillusioned.

    We are in a low yield world now, but over an investment life time things change. Further, even the current low yield and resulting SWR scenarios demand further attention.

    Finke, Pfau, and Blanchett previously studied SWR and the low yield environment “The 4 Percent Rule is Not Safe in a Low-Yield World” and that too suggested the old 4% SWR would struggle. For an equity and bonds portfolio, the concern is that if bond yields remain low the forecast equity returns are also downgraded to reflect the equity risk premium. However as Kitces pointed out, the low yield data assumed negative real bond returns when even the markets expect some returns (as represented by 30 year TIPS values at the time). At the time Pfau in response suggested it can “still be appropriate to start at 4% while maintaining flexibility to reduce spending later if needed.”

    Pfau (2010) also looked at global returns and concluded a SWR of 4.0%-4.5% as a baseline with a balanced asset allocation (40%-70% equities), with a lower 3.6% baseline where expectations are for sustained lower economic growth. He concluded that SWR expectations are lowered further (below 3.6%) only in cases of war or severe external shocks.

    In all cases these SWR were based on simple asset allocations and no additional strategies. But, as Pfau acknowledges, for a diversified global portfolio, not over-weighted with home bias or to any single market, there remains the potential to increase the SWR through active strategies, including Guyton Klinger ‘Decision Rules’, tilts (especially an allocation to small caps), and dynamic asset allocation. Any one of these can add 0.5-1.0% to a benchmark SWR, and combining strategies can increase the SWR further.

    So the message is, keep saving and investing. Over the long-term yields and returns may be better, and even if they remain mired where they are, it may still be possible to generate more income from your cash pile, without risk of portfolio failure, than the headline SWR figures currently suggest.

    SWR is probably an area worth a dedicated section on Monevator; it is highly relevant and of increasing interest as the investment journey progresses.

  • 51 weenie September 8, 2016, 12:01 am

    My lifestyle is nowhere near £30k pa – like SurreyBoy, I’ve worked out that it’s possible for me to get a decent FI/pension outcome on far far less than £1m, probably need around £300k and I plan on spending it.

  • 52 Massive September 8, 2016, 2:30 am

    Always intrigued by the focus on a 4% safe withdrawal rate.

    I have a strong expectation that I will still earn some income once I stop my current aggressive accumulation phase – I will consider myself fully independent once I reach a withdrawal rate of 10% – and anticipate that I will not run my assets down regardless as a result of some non-investment income.

    This is all definition dependent but I sometimes wonder if people get things all out of perspective by focussing on the 4/3/2.5% rule.

    Regards,

    Massive

  • 53 dearieme September 8, 2016, 4:46 pm

    I know someone who worried that his Final Salary pension would be valued at £1.5M for the purposes of an LTA calculation. All it needed was a lifetime of sound earnings and then two stellar promotions late in his career.

  • 54 John B September 9, 2016, 7:59 am

    I’m on holiday visiting stately homes where real millionaires have splashed their cash for 400 years, but I can visit dozens a year for a £60 HHA pass. To live like a millionaire means spending £100k a year, which needs a high earning job or huge investments, many million.

    But with a single million you never never never need to work again, and live a very comfortable life, and often much less is needed because of the favourable tax position on investments. You lose 30% of a salary in tax, while a well-managed ISA/pension combination should keep you under the £17k combined allowances, so you pay no tax. Combined with commuting costs, and trading time for money costs, and eventual state pension, a retirement income of 50% of the stressed-out working Jones’ next door should be enough.

    £1m should allow you to SPEND £100 a day for life, which is an awful lot, look at your life and work back from spending, not job income, and the magic pot could be much lower than that.

  • 55 Sara September 9, 2016, 11:47 am

    I have to refer you to this news report and I’m sure your local university / public/ health library will be grateful to be put in your will (cos the government ain’t coughing up anymore) –

    http://www.bbc.co.uk/news/world-us-canada-37310066

  • 56 Finance Solver September 10, 2016, 1:48 am

    This is what people don’t get. Millionaires aren’t made overnight (unless it’s the tech bubble era, but this is an anomaly) but over time. I’m hoping to make my first million in the next 15 years. It will be a hard goal but I believe that once I reach it, my growth will just accelerate even further. I have no doubt in my mind!

  • 57 VKK September 10, 2016, 4:36 am

    I was very fortunate as I had an opportunity to work in several countries in past 15 years as an expat. This sorted out my kids education and housing and i was able to save upwards of 80% of my salary on average including share options. All our savings are in equities outside of ISA .
    We were able to savings well over a million due to this unique opportunity. This accompanied by a final salary scheme will see us through . I had never imagined that I would be in this position .

  • 58 Richard September 10, 2016, 7:28 am

    Is the 4% (or 3%) rule to prevent any loss of capital or does it assume running capital down to 0 within a certain time period? So if I wanted to create Downton style generational wealth, would 4/3% allow me to pass all my capital down? Or would I have to spend less? And if I want to leave exactly £0 (or maybe negative) wealth at death, could I spend a higher percentage?

  • 59 theFIREstarter September 10, 2016, 8:45 am

    The key point for me here is the line “a country estate is something I’d hate”. I think too much wealth would just become a burden as you’d worry about where to spend it or who to give it away to. Or be tempted to buy too big a house or widgets that become the bane of your life with upkeep and so forth. I’d also like to keep earning a bit of money throughout my life and actually do it not literally just for fun (I.e. I feel like it is useful money) so having a million quid in the bank doesn’t really seem worth working all that time / hard for.

    On the other hand if there are any wealthy social scientists out there who want to run an experiment to see if my views would change once I’d tasted millionaire status I’m willing to be the lab rat 😉

  • 60 W Neil September 12, 2016, 9:05 am

    @Richard

    The original 4% rule was the result of work by Bengen (1994). It was based on 50% equities 50% bonds over a 30 year period.

    Higher SWRs can be achieved with more optimum allocations. The most sustainable withdrawal rates are achieved with equity allocations from 50% (but no lower) to around 75%. Higher equity allocations can achieve better returns with little long-term increased downside risk.

    Bengen later (1997) suggested that a 30% allocation to small caps on a 60% equity portfolio increases SWR 0.2%.

    To answer your question (partially) Bengen again (busy man!) (2006) found that decreasing the SWR 0.2% leaves initial principle intact (worst case).

    However it is important to understand the real significance of the 4% rule. The point which is often overlooked is that the 4% SWR meant that in every possible scenario – significantly this means all the worst market data and worst sequence of returns and worst combinations of low returns and high inflation during every 30 year period run through the number crunching – even if you had started withdrawing at the worst moment in investing history, your portfolio would have survived the 30 year period with, worst case, nothing left on the final day. However, in every other scenario, at the end of the period the portfolio would have cash left over, and in most cases double the original capital (inflation adjusted). In short, using the 4% rule meant that everyone who does not experience a terrible sequence of returns will leave a lot unspent.

    A quick analogy courtesy of Michael Kitces. In engineering the results of a Monte Carlo analysis must be incredibly accurate as failure cannot be fixed after the fact. For example, an engineering MC analysis giving a 98% probability of success and a 2% chance that a bridge could collapse would be unacceptable. So the bridge is constructed under MC simulations where the risk of failure as close to 0.00% as possible. But in the case of forecasting a SWR, a 98% MC success does not mean you run out of money 1 time in 50 lifetimes; it means there is a roughly 1 in 50 chance of running out of money if at some point you see the rocks ahead and do nothing to alter your direction.

    You do not relinquish control of your portfolio or your spending on day one and leave the rest to chance thereafter. A portfolio does not fail on the day an unprecedented 10 Standard Deviation annual global market decline occurs. The 2% is not the odds of absolute failure; it’s the odds of needing to make an adjustment.

    So if you want to leave money unspent, the odds are almost certain that you will, and if at any point it looks like it may not be the vast sums you imagined leaving unspent, then an adjustment can get you back on course.

    I hope this helps.

  • 61 Massive September 13, 2016, 2:23 am

    @ W Neil

    Brilliant post. Super clear.

    Thanks for posting.

    Massive

  • 62 SemiPassive September 13, 2016, 9:29 am

    Really surprised nobody has mentioned Thomas Stanley’s The Millionaire Next Door which explores the myth vs the reality of how the average millionaire lives.
    Often the average millionaire next door will drive a 5 or 10 year old car, vs the ‘millionaire wannabe’ next door who leases a new Range Rover Sport on something akin to a second mortgage.

    The ability to have enough FU money to sack your sucky employer or clients has to be worth at least 10 Range Rover Sports.

  • 63 Richard September 14, 2016, 7:48 am

    Yes,thanks W Neil, very interesting post!

  • 64 The Accumulator September 18, 2016, 11:54 am

    @ W Neil, could you link to the Pfau paper where he concludes that 4 – 4.5% is reasonable for a globally diversified portfolio?

    I’ve read a few studies where he concludes that 4% carries a high-possibility of failure across international markets because very few have enjoyed investment returns as consistently good as the US:

    http://advisorperspectives.com/newsletters14/pdfs/Does_International_Diversification_Improve_Safe_Withdrawal_Rates.pdf

    http://www.forbes.com/sites/wadepfau/2016/06/29/does-the-4-rule-work-around-the-world/#7a5b110e3494

    @ Richard – the 4% rule is the maximum safe withdrawal rate (inflation adjusted) that a US retiree could sustain over a 30-year retirement under the conditions modelled by Bengen. A smidge over 4% and the set of US retirees entering retirement on the eve of the worst run of results would have entirely run out of money before the 30-years were up i.e. they used all their capital. From memory, that was approx 1969, then their portfolios were ravaged by 1970s inflation and losses for bonds and stocks. By the time, the 1980s turned up to save the day, they’d already spent down too much of their portfolio to recover.

    But most US retirees – the ones who enjoyed a better historical sequence of returns – would have had plenty of money once their 30 years are up.

    Caveats include:

    The studies mostly use US investment returns since 1926. Many other developed world countries couldn’t match these returns – generally as a result of World Wars. Morningstar concluded that 3% was a safer bet for UK retirees in current economic circumstances:
    http://media.morningstar.com/uk%5CMEDIA%5CResearch_paper%5CUK_Safe_Withdrawal_Rates_ForRetirees.pdf

    30-year retirement period – if you fancy living for 40 or 50 years beyond your retirement date then safe withdrawal rate (SWR) goes down.

    Taxes and investment costs were ignored – these are very real costs but Bengen didn’t include them in his simulation. They bring down the SWR.

    Diversified portfolio – there’s some evidence that a more diversified portfolio than Bengen’s would do better as W Neil has indicated. Extensive historical data is hard to come by though. portfoliocharts.com has done a brilliant job on looking into this problem using data from 1970 on. Results are encouraging!

    You can up your withdrawal rates considerably if you’re flexible with your spending (i.e. reduce withdrawals and therefore your income in bad years) and can tolerate a higher probability of failure your money will run out.

    It’s worth knowing that the SWR is highly sensitive to the inputs both in simulations and in real-life! Small changes in circumstances lead to a wide dispersal of results.

    On the whole, I agree with W Neil that there’s more SWR flexibility than meets the eye from the headlines.

    Conservative me is aiming for a SWR of 3%.
    Party me thinks that I could be fine on 4% or even higher but that depends on being able to cut my income back when the chips are down. Flexibility is key.

  • 65 W Neil September 19, 2016, 8:42 pm

    Absolutely. Flexibility is key.

    I was wrong to cite Pfau as stating 4.0%-4.5% in that paper. His study showed that SWRs outside of the US were often awful. But there was a correlation with the impact of the World Wars on country SWRs. I think it may have been Kitces that suggested 4.0%-4.5% if you exclude the war scenarios from the international SWRs. This was Pfau’s research http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1699526

    For what it’s worth, Pfau responded in the comments section of an article by Kitces and both seem to acknowledge the scope to boost a SWR back to around 4% with optimized allocations and flexible drawdown strategies.
    https://www.kitces.com/blog/safe-withdrawal-rates-in-todays-low-yield-environment-walking-on-the-edge-of-a-cliff/

    Flexibility and optimum asset allocations is the key and in this respect the Guyton Klinger decision rules strategy is interesting http://www.cornerstonewealthadvisors.com/wp-content/uploads/2014/09/08-06_WebsiteArticle.pdf

    One could reduce Guyton Klinger’s 5.2%-5.6% SWR quite a bit to make allowances for US-bias or lower future returns and still end up with around 4%. One of the attractions of this strategy is that even if a reduction in income is required at some future point, the reduction will probably still only take you down to where you would have been anyway on a vanilla annual inflation increases SWR approach.

    http://www.cfiresim.com/ can be useful too. Unlike portfoliocharts it doesn’t have the option to explore the higher potential SWRs from wider diversification or allocations to small caps, but it does include options to test flexible strategies and factor in other income such as state pensions kicking in after so many years. Both make tangible differences to the initial SWR.

  • 66 W Neil February 20, 2017, 9:00 am

    An update to the previous comments about Guyton Klinger Decision Rules for SWR. Subsequent research suggests that the GK rules need a caveat.

    Their published research selectively reports the higher amounts that can be withdrawn as a percentage of total portfolio value. In adverse conditions their ‘guardrails’ require relatively small downward adjustments in the percentage withdrawal rate. But their results did not report what the reduced annual withdrawals would be equal to in inflation adjusted cash terms.

    In very adverse conditions the GK rules alone may not preserve the portfolio value sufficiently to enable the SWR claimed while also maintaining the withdrawal amounts in inflation adjusted terms. Taking too much (i.e. their claimed achievable SWR) at the beginning may mean accepting large reductions in inflation adjusted income later on.

    This is not to say GK rules do not have any value, or that a flexible approach to withdrawals doesn’t have a place. A flexible approach may be preferable to sticking to a fixed withdrawal rate regardless of circumstances. But if using GK rules it may still be better to start with a lower withdrawal rate than they claim it can deliver.

    A link to this alternative perspective on GK decision rules is here – https://earlyretirementnow.com/2017/02/08/the-ultimate-guide-to-safe-withdrawal-rates-part-9-guyton-klinger/

  • 67 The Accumulator February 20, 2017, 6:45 pm

    Thank you for following up W Neil. Will take a look at the new research as soon as I can. I’m planning on using some version of a dynamic withdrawal rate so interesting that they are being challenged.

    Btw, are you already drawing down or will you do so in the near future? Have you formulated your own approach yet? I ask because you clearly have a strong grip on the topic and I’m interested in any conclusions you’ve reached. Firm or otherwise!

  • 68 W Neil February 21, 2017, 5:51 pm

    @The Accumulator
    I’m a few years from drawing down but trying to gain as much information now. I haven’t settled on a strategy yet, but it is likely to be something dynamic. Will be glad to share any ideas and anything I find of interest.

  • 69 W Neil February 27, 2017, 6:01 pm

    @The Accumulator,
    If considering a dynamic approach I can recommend Living Off Your Money by Michael McClung. He is of the view that standard annual rebalancing as followed during the accumulation phase is not best followed when withdrawing income. He thoroughly tests existing dynamic withdrawal strategies and also puts forward his own which he calls ‘Prime Harvesting’. It’s not a light read but whether or not you chose to follow his strategy it’s worth it for a thorough examination of the subject.

  • 70 The Accumulator March 2, 2017, 10:13 pm

    Thanks for the recommendation W Neil. It’s on my reading list. I agree, btw, at some point I’ll settle on a dynamic method. Flexibility looks like an important bulwark against sequence of return risk.

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