The Ultimate Objective for your passive income portfolio

By: ispeculatornew
Date posted: 01.26.2011 (6:00 am) | Write a Comment  (4 Comments)

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We have discussed passive income portfolio investing before, its importance and how it can lead to a superior lifestyle. By now, you have hopefully started building that portfolio, especially since you can start one with as little as $5000! I wanted to reflect a bit on the idea behind a passive income portfolio… let me know your thoughts

The goals of a passive income investor

It might sound obvious but the ideal is not to be able to pay for your retirement, the foal is more ambitious. In an ideal world, the income generated by that portfolio would be enough to be self-sustaining. What is the distinction?

When financial planners go into the numbers of what you need for your retirement and how to get there, one of the variables that they use is “expected lifetime”. Yes, that is exactly what you think. They are trying to help you save just enough money to make it until your death. Sure, they include a little cushion but there is still a major difference. Why? Because if you are expected to live until 85 years old, as you get older, that estimate might change, which would also impact how much income you can live with during your retirement. One thing you want to avoid all cost is over-living your budget.

So what is it that I aspire to?

I want a portfolio that can help me keep the same level of income, even if I live for the next 100 years. Sounds impossible? It’s not. It’s actually quite simple. You simply need your portfolio to do 2 things:

-Generate enough income to live off of without touching your capital
-Have the capital increase by the inflation rate

Why is the inflation rate crucial? Imagine that you have a $1,000,000 portfolio, which used to be considered ideal but is now insufficient for many of us. If you are able to generate 4.5% of income, which seems reasonable, you would be receiving $45,000 per year. But how much will you be able to do with $45,000 in 20 years? Not a whole lot. This means that you want your $1,000,000 to increase over time in order to have that 4.5% still give you the same lifestyle even when prices increase.

How to get it done?

There are many different ways and using inflation hedges such as TIP’s or gold is certainly one such way but I think the critical part here is to account for inflation when you make your calculations. It will take away any stress about over living your portfolio. In this case, if you estimate that inflation will be 2% on average, and that you can get 5% of total return, that means you will actually need to be able to live off of 3% of your portfolio every year. If you want to receive $50,000 per year, that means closer to $2 million than $1 million. There are many ways to get it done but I just think it’s critical to know what you need and plan in function of that.

If you’re not going to make it

Do not give up hope however, there are other ways to get the same result and one of those ways that is used by many is buying an annuity.  When you buy such a financial product, you basically buy a stream of cash flows that will be paid out every year until you die. Many different conditions can be added and that stream can be adjusted for inflation, can pay a sum at your death, etc. I will discuss annuitites later on but I think it’s a good way to reduce uncertainty about your future income if you know that your retirement will come up short.

If your passive income portfolio is generating enough

If you succeed in making a portfolio that can both pay you enough passive income and account for inflation, you will have a very happy problem once you reach retirement. You will have a passive income portfolio that you will be able to give away to a loved one or to charity. I certainly hope and plan to be able to do that once I move on to another life and hopefully many of you can do the same…

What are your big plans for your passive income portfolio?

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4 Comments

  1. Comment by Jfid — January 26, 2011 @ 6:40 am

    If with your passive income you’re able to generate enough income to live off of, that’s the end. You are rich. You can wake up in the morning and don’t go to work. It’s the first level of rich people.

  2. Comment by Mihou — January 26, 2011 @ 12:23 pm

    Hi everyone,
    As a dividend investor,i am about to choose 2 stocks between four which are :TA.TO,NWF.TO ,ENF.TO ,AGBF-B.TO.
    Please give your thoughts
    Have a nice day

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