Can You Live Off Investment Interest?

It’s a time-honored retirement income strategy: Create a portfolio that can deliver investment gains that are high enough that an investor could live off the interest or investment returns and not touch the principal.

While that goal is still possible for some people, thanks to persistently high inflation levels, this is a harder benchmark to reach today than it was a few years ago.

Not only has inflation added to the cost of living calculations for retirement planners as well as retirees, there’s also the challenge of longevity. With many people living longer than they expected, that means successfully living off investment income requires careful planning and diligence.

How Much Money Would It Take to Live on Interest?

In order to live on the interest from your investments in retirement, you have to take several factors into consideration, including the size of the portfolio that you’ll need to build when investing online or through traditional channels, as well as potential market returns. Other questions include:

•   Timing. When will you be using the money: Do you want to live off investment income in retirement, or sooner?

•   Cost of living. What are your potential expenses>

•   Duration. How long will you potentially be living off investment interest or income?

•   Rate of return. How much income, or gains, can your portfolio potentially generate, so that you don’t have to spend down the principal?

Calculating Potential Investment Income

Once you have a sense of the amount of money your lifestyle requires, you can run some basic calculations regarding how much money it would take to provide the income you need.

For example, a portfolio of $1 million might have the potential to generate 5% per year in investment returns, or $50,000, depending on how the money is invested, the actual market performance, the cost of investment fees, and so on (though there are never guarantees).

There may also be tax implications, depending on whether you open an IRA and invest your money in this type of tax-advantaged retirement account, or in a taxable account.

If you’re planning to retire, and combine that potential investment income with your Social Security pension, for example, your investment gains could provide enough money to live on. But creating a steady amount of investment income that you can count on, year in and year out, takes careful planning and money management. Plus, investments are always subject to the risk of loss.

Recommended: Stock Market Basics

The “Principal” Principle

For an interest-only retirement plan to work, it’s wise to follow the rule of only spending the interest and not touching the principal — which is the total cash you’ve deposited and invested.

Mortgage holders may be familiar with the definition of principal as the amount you borrow; interest is what the bank charges on top of the principal loan amount. It’s a similar concept with investing: Principal is the amount you deposit; investment gains or interest are what the principal earns.

Ideally, long-term investors don’t touch their principal investment — whether they’re buying stocks, bonds, mutual funds, or other investments — as that money needs to remain invested in order to keep earning potential gains. This is known as the principal principle. After all, a decreasing amount of principal results in a decreasing amount of investment income.

Making Interest-Only Income Work

In addition to sticking with the principal principle, there are a few other key strategies people use to successfully live off of investment interest.

•   Budgeting. One strategy investors might use is living below their means. If someone makes $60,000 a year from potential investment interest/gains, and they spend $54,000 a year on living expenses, that leaves them with extra money in case of emergencies and unforeseen expenses.

Alternatively, they can choose to invest the money back into their portfolio, and thus increase the principal amount.

•   Planning. Making a strategic plan early in life can help you achieve financial goals. One way to start making a plan is by working backward, starting with the desired amount of monthly income based on expenses and lifestyle goals, and then how to save and invest enough to get there.

•   Return on investment. The next important factor is to understand the potential return on investment and how different investment choices can impact returns. Stocks may offer higher returns, but more risk. The long-term historical growth rate of the S&P 500 is around 6% or 7%, after inflation. This index is often taken as a proxy for the stock market as a whole.

Bonds and other securities that pay steady rates of return may offer less income, but also lower levels of risk.

•   Planning for longevity. Human life expectancy is higher than ever. Investors should plan to cover the cost of living into their 80s, 90s, or even to 100. If you retire at age 65 or even younger, cash flow may need to cover more years than you originally planned.

Expenses may increase with age due to medical needs.

•   Taxes. Changes in tax rates, income taxes, capital gains tax rates, and other relevant costs should all be taken into consideration.

A Few Tips for Retirement Saving

Beyond having financial goals and a plan, there are a few other ways that investors can make saving money easier.

Set up Automatic Savings

Setting up automatic transfers into your savings, retirement, and investing accounts is an evidence-based strategy that can help people save more. Research shows that when people save automatically, especially for longer-term goals like retirement, they tend to be more successful in sticking to their plan.

Using basic tools like automatic transfers and deposits helps to overcome human inertia and other impulses that can derail your plans.

There’s another advantage to using automatic savings, which is the ability to lean into another strategy known as dollar cost averaging. With dollar cost averaging (DCA), you invest the same dollar amount on a regular basis (e.g., weekly, bi-weekly, monthly, etc.), regardless of market conditions.

This strategy spreads your investments over time, which has been shown to help reduce the impact of volatility on your overall portfolio.

Avoid Lifestyle Creep

If investors consistently live below their means, they might have money left over to put into savings. It can be easy for people to start spending more on food, travel, housing, clothes, and other items as their salary and savings accounts increase. By avoiding lifestyle creep, investors can more easily reach their goal of an interest-only retirement.

People often think their expenses will go down when they retire, because they won’t have to buy work clothes, pay for their commute, buy lunch, and other day-to-day costs. However, retirement costs, like travel and leisure, as well as medical expenses, can add up quickly. Investors should expect to spend up to 70% to 90% of their pre-retirement expenses during their retirement years.

Keep a Long-Term Mindset

When it comes to retirement accounts, consider sticking with low-risk, long-term investments. Buying and holding helps investors avoid short-term capital gains taxes and may help mitigate market risks over time.

In addition, most Americans pay into Social Security, and the amount they’ll receive in retirement depends on their date of birth and lifetime income. Investors can estimate their Social Security earnings by visiting the SSA website.

Thus, by saving small amounts over a long period of time, and potentially seeing investment gains compound, living off of interest could be possible.

Building an Interest-Earning Portfolio

Once an investor knows what their goals are for retirement and how much they’re able to save each month, they can start to explore investment options. Long-term, lower-risk investments such as bonds and certificates of deposits (CDs) tend to provide more consistent interest income.

Still, it’s important to keep in mind that even relatively “safe” investments have risks — all investments do. This is why portfolio diversification may help offset some market risks. By spreading out money across different types of investments, investors may be able to balance risk and return potential, though diversification can’t fully protect investments in a declining market or guarantee profits.

Below are some types of investments that might be considered for a retirement portfolio.

Bonds

The most common type of interest-earning investment for retirement portfolios is bonds. These can be Treasury, corporate, or municipal bonds.

Each type of bond will come with its own risks, such as price fluctuations, changes in the market, and the possibility of default. One strategy investors use to avoid some of these risks is called laddering. This is when investors buy bonds with varying maturities, which is the date on which the life of a bond ends. At the maturity date, the borrower must pay back the principal to the investor, or the bond may be renewed.

Diversifying among different types of bonds is a good idea when building a portfolio. It’s also important to pay attention to changes in interest rates, both for bonds and other types of investment.

Mutual Funds

Some investors choose to invest in mutual funds, which are made up of money pooled from multiple investors. The pool of money is invested into bonds, stocks, and other assets, which are chosen and managed by professional money managers.

Although mutual funds can pay out earnings and dividends, they aren’t as consistent or predictable as bonds. The funds are made up of multiple securities that can all change over time. If an investor is trying to keep their principal invested and only live off of interest, but the amount of interest they earn fluctuates significantly from year to year, this may not work.

Annuities

Another type of interest-earning investment is an annuity. There are many types of annuities available. At its most basic, an annuity is an insurance contract. The buyer, often a retiree or pre-retiree, agrees to pay a certain amount of money to the insurance company, either in a lump sum or over time, in exchange for a series of fixed or variable payments.

Annuities can be quite complex. The terms, fees, and rates of return vary widely for these products. It may be wise to consult a professional before buying an annuity.

The Challenge of Inflation

Unfortunately, living off of interest isn’t a simple or direct proposition. This is due to inflation, which devalues the dollar each year. Inflation is the rate at which the price of goods go up, causing the purchasing power of the dollar to shrink.

Although the amount of investment income earned each year might stay the same, the amount of goods and services that can be purchased with that amount of money goes down. Investors can estimate and plan for inflation as they create their retirement goals and plans, but they might have to save up quite a bit more and keep their monthly expenses down in order to avoid violating the principal principle.

One type of investment that is designed to protect against inflation are TIPS, or Treasury inflation-protected securities. TIPS are Treasury bonds that rise in value as inflation rises. U.S. Government-issued TIPS pay out interest every six months, and the amount paid goes up as inflation rises. With maturities of five, 10, or 30 years, TIPS are purchased in $100 increments directly from the government, or through ETFs (exchange-traded funds) or mutual funds.

The Takeaway

Living off of interest depends on a number of factors, including monthly savings, investment choices, and lifestyle needs. Determining goals and realistic monthly savings amounts is the first step. If investors do their homework to figure out how to live off interest successfully, it could be achievable.

Once investors have a plan, they can start building a strong, diversified portfolio for retirement.

Prepare for your retirement with an individual retirement account (IRA). It’s easy to get started when you open a traditional or Roth IRA with SoFi. Whether you prefer a hands-on self-directed IRA through SoFi Securities or an automated robo IRA with SoFi Wealth, you can build a portfolio to help support your long-term goals while gaining access to tax-advantaged savings strategies.

Easily manage your retirement savings with a SoFi IRA.

FAQ

What is investment interest?

When you invest money in the financial markets, perhaps through a retirement plan or a taxable account, ideally your money will “earn” additional gains through investment interest or investment returns. Some investments, such as bonds, pay a steady rate of interest that may help create an income stream. Other investments, such as stocks, mutual funds, or ETFs, may see gains if the underlying companies perform well. In either case, there are no guarantees, and investors have to be prepared for the risk of loss.

Can I live off the interest on $500,000?

The interest on $500,000 would likely be too low to live on, by itself. For example, a $500,000 portfolio invested in 10-year Treasurys that earns 4.5% (roughly the current yield on a 10-year Treasury note) would pay about $22,500 per year. If the $500,000 was invested in a mix of securities that included higher return (but higher risk) choices, it might be possible to earn more. But again, there are no guarantees.

What sources of income do I need to live on in retirement?

Once you’ve decided what your retirement living expenses are likely to be, you can think about how much income you’ll potentially have coming in. You may have investment returns, Social Security benefits, a workplace pension, or perhaps another stream of income (e.g., from a rental property or other business). While all of these are possible, and there are additional income options as well, it’s wise to add them up and see if you need to make any adjustments so that your income covers your cost of living.

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