How to Turn Existing Savings into Passive Income
Many people look at their savings as money they can spend in the future. But I like to think of my savings as a perpetual generator of income instead. The difference is once you spend money in the future it’s gone. But if you have a machine that brings you a steady stream of income then that cashflow is perpetual. 🙂 It’s better to have a goose that lays golden eggs than just a pile of golden eggs.
This means when I save $1,000 today, I don’t deem that money “spendable” anymore. Instead that $1,000 of savings have been changed into $40/year of passive income (or 4% of the saved amount) for the rest of my life. 😀
Many actuaries and financial experts like to use the 4% rule because it represents a sustainable draw down rate over a long period of time. On a similar note, when I occasionally sell my investments to pay for large purchases, I also think of that as stealing income away from my future self.
The power of compounding
If one manages to save $1,000 a month and make an investment return of 4% above inflation every year, then after 32 years of working, he or she will have about $750,000 of investable assets, which that person can draw down from at 4% a year, or $30,000 of spending money forever.
With $30,000 of income every year coming from our nest egg, plus maybe $20,000 from government assistance/private pensions, we can expect to live quite comfortably on a $50,000 annual income. Not everyone is able to save $1,000 a month, but statistics show that men who live on the west coast like myself plan to save on average about $15,000 this year. So for most people, $1000/month of savings, if not more, is to be expected. One way I like to save is to cook my own meals most of the time because eating out can be quite costly.
Don’t have to start large
Personally my savings rate is about $1,500 to $2,000 a month thanks to my side hustles. So I plan to retire quite a bit earlier than 55. In fact, according to my latest net worth blog post, I already have over $750,000 of financial assets today. 😉
However that’s not the entire story. The reality is that I only have about $175,000 of investable, liquid assets. The remaining $575,000 is locked up in long term, capital appreciating resources such as my home and my farmland. Nevertheless building up $175,000 of stocks and bonds over a 5 year period still sounds pretty far-fetched given my average salary.
Luckily there’s a wonderful tool called leverage that has made all this possible! Instead of buying stocks in a regular trading account, I have a margin account which allows me to invest with borrowed money and I was able to double the performance of the S&P 500 stock market index over the last few years!
Our age and risk tolerance will influence our asset allocation but generally speaking we should be able to sustain a 4% withdrawal rate by investing 60% of our money in equities, and 40% in fixed income. In terms of geographical allocation we can go with a 50/50 North American and international split to stay diversified. We then rebalance our portfolios to meet these ratios once a year. 🙂
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Random Useless Fact: What is a 4 letter word, yet is made up of 3. Rarely consists 6 letters, and never is written with 5.
Hint for the riddle above: Think about why it’s under the Random Useless Fact section 😉
We think the same….
I have a grin ear-to-ear when I’m able to save $1,000 in our RRSPs or TFSAs. That means another $40/year of passive dividend income in retirement. Our goal is to increase our dividend income by at least $40-$50 every month, without dividends being reinvested. Add on the positive effect that DRIPs can provide and hopefully we’re living off about $30,000 of income every year coming from our portfolio without ever touching the capital in 15 years.
Add in $20,000 from the government via CPP and OAS, pensions and other assets, and we should be able to live from $60,000 per year in 2030 dollars.
Mark
I like how you’ve calculated the retirement income in 2030 years. Way to think ahead 🙂
If you invest $1000 for dividend growth stocks, you will get much more than $40/year for long term, and you can simply ignore the inflation too.
Yes, it’s important to put most of our stock in companies that have a long history of growing their distributions 🙂 My average dividend yield on my portfolio is only about 3% right now, but it should keep up with inflation over time.
Ignore inflation at your own risk! 2% Inflation means the dollar will lose 75% of its value over the course of an average lifetime!
It’s the slow but steady killer of wealth for many people. Inflation is even worse south of the border. Since 1900 the U.S. dollar has lost over 95% of its purchasing power. That’s why I’m not a fan of emergency funds. I don’t want to lose 2% a year on $10,000, when I could be making money from my savings 🙂
Nice way of seeing savings as future income. Not a lot of people can save $1000 consistently through the years unless they bring home a higher income. Too often we have too many obligations to pay before we can save any money.
That’s true. $1,000 a month is just the average expected savings rate according to BMO, but many people don’t have that much to save, especially if they have expenses not within their own control.
Dude… You need to e-mail me. My options trading strategy is been proving itself VERY robust week after week after week. If I had your capital base, I would be livin’ large!
Thanks for the reminder Blerghhh. Sorry for the delay in the email. Been going through a backlog of emails lately. I’ll get back to you on that shortly.
For me savings is time/freedom. $1,000 today is the possibility to live for a week or two, somewhere down the road, without working. If there is 4% on top, even better.
And yes, “what” has 4 letters!
Yup, freedom is ultimately what I’m going for too! Congrats on solving the riddle 🙂
It’s really such a simple concept and it’s amazing how relatively small amounts will add up to big amounts given enough time. Can’t do $1,000 per month, try $500 and then see what you can do to get it up to $1,000. There’s lots of opportunities to either cut expenses or earn some side hustle income to boost your savings.
That’s right. There are always ways to improve one’s financial situation. Many people source inflation as a barrier to saving more money, but inflation means people are making more money too because whenever we pay more for something, that inflated sum of money becomes someone else’s income 🙂 Opportunities always exist if we look for them.
I will say 4% is very conservative. Our 10yr return all said and done, including the MAJOR stock crash at the end of 2007/2008, has been 4.9%. Given that this has been a rather non-typical 10 yr cycle (yeah right – it’s typical…), I’d say based on my experience and data 4% in quite conservative. As to saving $1000/ month, When my wife and I were starting out we were saving one of our salaries for the long term, so about $3000 after tax each month. This is why I can be an at home dad now and why I stopped “working” at 40. Now to one of your points, yes I understand margin/leverage and debt, but anyone using it needs to understand what can happen when it goes wrong… So always keep a handle on the borrowing. Now that I am not working, I tend to track how our net worth grows, and again if I average out that number over the last 10 yrs it has been 11%. Given that my wife plans to work another 10yrs at her job, a) because she likes it, and b) because she’ll acquire a nice pension from it,at that point anything… Read more »
Sharing wealth and experiences with family and friends is probably the best investment of all in terms of both financial wealth as well as relationship wealth and well being 🙂 Often it’s not what you know but who you know that can open doors to new life opportunities.
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All around the world people teach their kids to study hard, work hard, and be successful. Not a lot of people teach their kids about finance. Hence, people are always complaining about not having enough money. If you invest rightly then you will have your money working for you. The revenue generated from your investments should be enough to have a luxurious retirement life. So, one must start saving and investing early.