Sunday, August 05, 2007

Who wants to be a millionaire?

Back in the old days (1960's?), being a millionaire was a really big deal. It meant that you were "rich" and didn't need to work unless you wanted to just for the fun of it. Now, it's hardly even notable, and probably doesn't even mean you can depend on a decent standard of living unless you continue to work. It fact, it may be more of a curse than a source of great joy and satisfaction.

First, we do have to distinguish between "wealth" and liquid wealth. You may have inherited a stake in a privately held company which you cannot sell and pays only a very small dividend. Your wealth may be growing every year, but there may not be an easy way to cash any of it out. Similarly, you might have a house which is now worth north of a million, but that doesn't put cash in your pocket (other than borrowing, which doesn't count as "wealth.")

Second, I wouldn't say that you are "rich" unless you are sustainably rich for the rest of your life and will be able to pass on the bulk of that wealth (even adjusting for inflation) to your heirs. So, financing your standard of living by selling capital, thus reducing your wealth also doesn't count as being "rich."

In other words, you need to be able to live off of the income from your wealth to even be at the low end of "rich."

The gold standard for "rich" has to be having enough cash in Treasuries or dividend-paying quality stocks or income-producing real estate so that you can live off the interest and dividends and other forms of investment income while that part of your wealth in income-producing investments also increases in value (on average, say over a ten-year period) faster than inflation.

So, what does a million earn you even in Treasuries?

At the latest weekly Treasury auction, 13-week (3-month) T-bills yielded an investment rate of 4.97%. That would compound for an annual yield of 5.08%. So, a million would earn $50,800. Of course you are spending the interest, so there is no significant compounding, so lets just call it 5%.

These days, who can live on $50K?? Oh, and that is before taxes. Take out 28% for the feds and say another 5% of state and local (total of 33% or one-third) and that $50K shrinks to a mere $33.5K. Try finding anybody who would voluntarily live on $33.5K a year -- and feel that they are living "rich".

Oops. I forgot inflation. If you figure a conservative 3% for inflation, you need to subtract that from the interest rate of the T-bills, turning 5% into 2% or $20K a year. The good news is that your marginal tax rate would only be 15%, so you get to keep and spend a whopping $17K a year. Just keep telling yourself that being "rich" is not just about the money!

What about TIPS rather than T-bills? The 5-year TIPS has a 2.46% yield with the principle "protected" against inflation, BUT the inflation indexing is taxable, so basically you are screwed in most cases. Even the 30-year TIPS has a yield of only 2.35%. Oh well. Nice idea though. In some cases TIPS might work out, but they add some complexity to the math. 

So, what if I had 2 million in liquid wealth? Protecting $2 million from inflation, 2% yield on 2 million is $40K (minus some since you'd be in a higher tax bracket.) Still hardly above the poverty level.

3 million would give you $60K, which might let you live in a boring suburb outside a boring city.

4 million would give you $80K, but still wouldn't get you into even a half-way decent place nor let you go on expensive vacations to exotic places.

5 million would give you $100K, which might just barely allow you to live in a way that you could give the appearance of being rich but "choosing" to live relatively frugally.

Even 10 million in T-bills would give you only around $138K a year once you take out taxes.

Sure, you can "chase yield" and find other investments which have a higher yield, but what looks great this year might be down in the toilet in even a mere 18 months.

20 million... would give you an income of about $260K after taxes, which is almost beginning to sound like some "change" that would enable you to actually comfortably pass yourself off as rich.

OTOH, what if interest rates fall or inflation rises? Best to double that 20 million and round it up to an even $50 million. I would suggest that as the "gold standard" that we should use for being "rich" these days. Anything less and you are skating on thin ice.

And remember, that is $50 million in liquid wealth such as Treasuries and high-quality dividend-paying stocks or stable income-producing real estate. You should not count any speculative investments (e.g., hot Internet stocks, venture investments, real estate speculation, etc.) when calculating your "wealth."

Back in 2000, there were actually a few short periods where my own "wealth" was slightly north of the one-million mark. But, as they say, "wealth is fleeting." I looked at my options and decided that my best two choices were: 1) move to Gary, Indiana or some other god-forsaken place where I actually could live semi-comfortably on $30K a year, or 2) "just one more year of great stock market returns" that would double my wealth and then I would be able to "retire" semi-comfortably. I chose the latter path and, as they say, the rest is history, although not exactly the result that I had predicted. I'm torn over whether I made the right choice about my "Gary, Indiana Solution." I doubt that I would be happy there, but who knows. Sure, it was painful going through a big decline in wealth and going through bankruptcy and having to get a "real" job again, but how do you compare and balance risk and potential pain against unhappiness?

Needless to say, I don't have even 1 million, let alone 50 million in "wealth", so I don't have this kind of dilemma to deal with, and the odds are, I never will. Actually, I do remember a Saturday Night Live episode parodying President Ford's WIN scheme (Whip Inflation Now) and President Carter's struggles wth inflation, with the amusing lines "Inflation is our friend... in the future, we'll all be millionaires!"

For another view on the "plight" of millionaires who still need to work, read the article in The New York Times by Gary Rivlin entitled "In Silicon Valley, Millionaires Who Don't Feel Rich."

Anyway, time to get back to the salt mines.

-- Jack Krupansky

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