When people come into large sums of money, the first thing they usually want to find out is if they can quit their jobs, financial advisers say.
If you share this dream, you might be surprised at how little–or how much–it takes. In fact, the amount of money it takes to quit is a personal matter. It’s determined by how long and how well you plan to live, how cleverly you invest and whether you want to leave money to your heirs when you die.
Indeed, some people may have enough money saved already to ditch their day jobs and follow a dream of leisure or more rewarding work. How do you figure out whether your personal stockpile spells freedom?
First, figure out how much annual income you want and what rate of interest you expect to earn on your money. Then simply divide the income amount by the interest rate. The result is the amount you’d need to have invested to generate your target amount of annual income.
For instance, if you figure you need $35,000 annually, and that the money you have saved to generate that income will be invested in 7 percent Treasury bonds, you divide $35,000 by 7 percent to find that you’d need $500,000 invested.
You need $50,000 in annual income? Divide $50,000 by 7 percent. You’d have to have $714,286 invested. If you can’t live on less than $65,000, you’d need $928,571. Those who want a fairly opulent $100,000 annually would require $1.43 million in T-bonds. But those who figure they could get by on a modest $25,000 annually would simply need $357,143 invested.
What if you don’t mind spending all or some of the principal? The calculation becomes a bit more complicated because you have to estimate how long you’ll live. You’d also need a present-value calculator to figure it.
What’s a present-value calculator? It’s a calculator with an extra row of keys labeled PV, FV,% I, PMT, N and CPT. These calculators allow you to easily figure compound interest–or, in industry jargon, “the time value of money.” (You can buy an inexpensive present-value calculator at most office warehouse stores for $20.)
The calculations are easy but a little unfamiliar. That’s because most people are accustomed to plugging in a couple of numbers and a symbol, such as multiplied by or divided by, and getting an answer.
With a present-value calculation, you’ll need to put in more information before you ask for a result. There are five questions to deal with:
– How much savings do you have–or need–now? That’s the “present value,” or PV, key on the calculator.
– How much you want in the future? That’s the “future value,” or FV, key.
– How much time do you have? For that you use the “number of periods,” or N, key.
– What’s the interest rate you expect to earn? That’s the “percent interest,” or% I, key.
– How much money you want to receive in each period? For this you use the all-important “payment,” or PMT, key on the calculator.
If you know–or can estimate–the answers to four of these questions, you can solve for the fifth. The questions can be answered in any order, but the question you solve for must be last.
In this case, you want to know how much money you need to have today–the present value–to earn a set amount of income each year for the rest of your life.
To solve, you have to guess how many years you’ll live. For example’s sake, we’ll look at someone who is now age 45 and expects to live to age 95. That means he’ll want annual income for 50 years. So, he’ll plug “50, N” into his present-value calculator.
Because he wants to be safe, he figures his savings will be invested in Treasury bills at 7 percent annual interest. He’ll next punch “7,% I” on the calculator.
He wants to leave his relatives $100,000 when he dies in 50 years, so he’ll plug “100,000, FV”–the $100,000 future value of his savings–into the calculator.
He’s happy with annual income of $35,000, so he plugs “35,000, PMT” into the calculator.
Now to find out how much he needs invested to get that amount of income, his last step is simply to hit “CPT, PV”–for “compute present value.” The result: $486,421.
