What Amount of Money Makes You Rich
The obvious answer is there is not a set amount, but there is a method to calculate what makes someone rich. Our personal definition of rich (not the calculation) means you have enough money to accomplish all your goals without having to work or, just as importantly, invest aggressively. In our opinion, if you need a 10% annual yield on your investments to realize your goals, you’re not rich. We know people who, using our definition, weren’t rich, but lived like they were because they had 100% of their money invested with Bernie Madoff at a 10%+ annual yield. They set their investment strategy to match their lifestyle needs instead of adjusting their lifestyle to their reasonable estimates of returns.
The assumption of growth of your capital and the income associated with it should, in our opinion, be modest. We assume 2% income, in a conservative, dividend based portfolio, with 3% earnings growth for a total return of 5%. These are real return estimates. Your nominal returns are expected to be higher as a result of inflation.
For this analysis, we assume you do not have income for a job, business, or other endeavors. If you earn $2M/year as a trader, trying to quantify how long you can depend on that income is beyond the scope of this article.
The first question to answer is what are your goals? We’ll look at a couple of different sets of circumstances, so you have a feel for how this process works.
Scenario one: you’re a married couple, 65 years old, you have a couple kids who have good jobs and don’t need financial support. When you pass away, you want to leave them a meaningful estate.
You own your house and are debt-free. You live in a state that doesn’t have an income tax. You and your spouse love to travel and you fly first class. Your annual expenses are $250K. Assuming a blended tax rate of around 17%, you’ll need income of $300K. If you hold a portfolio of high quality, dividend producing stocks yielding 2.5%, you would need to have a $12M portfolio ($300,000 / 2.5%) that is fully invested. Let’s add another $2 million in short-term T-Bills for additional safety.
Based on these lifestyle conditions, having $14M plus the value of your home would make you, in our opinion, rich. You can live your life the way you want to without being concerned about running out of money. Your dividend income should grow in excess of inflation. You will get some additional income from the $2M in treasuries. You can cover your expenses without having to access your principal. My dad ingrained upon me from the time I was a kid, “spend your interest and dividends on whatever you like but don’t touch the principal.” That lesson has been one of the best I’ve received from anyone.
The reason to go through this exercise is to help you match your risk to your needs. With a liquid net worth of $14M, you have no need to move up the risk ladder. You can stay on the first rung.
Scenario two: you’re a married couple with three young children ages 6, 7 and 8 who attend private school in NY. You expect them to go to a private college and then some type of post-graduate schooling (medical school, MBA, JD). Your blended tax rate is 30%. You own your home and your expenses outside of tuition are $400K and are expected to rise with inflation.
This calculation is more complex than the first example, so we’ll use some estimated numbers. Currently, tuition at Horace Mann private school is consistent for grades K – 12 and clocks in at $60K/year. I just finished paying my daughter’s tuition at an out-of-state, private university and that was $82K/year. Tuition at top-tier schools tends to rise in excess of inflation. We’re not going to build a spreadsheet for this example, so we’ll ballpark tuition at $67K/year forever (it will seem like forever if you have a few kids and tuition bills from pre-K to college and beyond).
You need an after-tax income of $600K that rises in excess of inflation. A 30% rate requires a pre-tax income of $860K. Using the same dividend yield of 2.5%, you’d need a portfolio valued at around $35M if you don’t want to rely on your work income to fund your lifestyle.
Many families go to an investment advisor to help them quantify their goals and set up an investment plan to reach them. Instead of paying 0.5% to 1% of their portfolio to an advisor forever, they can go to an accountant or a financial advisor that charges by the hour. Either should be able to help them with their planning at a significantly reduced cost.
I’ve talked to successful people who set their financial goals based on a number they imagine will fund their needs. It might be $20M. Once they get to $20M, they increase the number to $30M for no reason other than either they need a goal to reach for or their friend group has more money than they do. It’s great to have a goal, but you should be cognizant of the level of risk you're taking to reach a goal, especially if the goal is not directly related to your needs.
