We’re supposed to be on the verge of the greatest wealth transfer in human history. That’s what will happen as aging boomers pass their $30 trillion in wealth to the next generation.
Sounds like a lot of money, doesn’t it? Well, not so much.
Inheritors will make a painful discovery. While some have visions of mad shopping sprees — a Bentley in the driveway, a wall of Jimmy Choo shoes or just a Blue Crocodile Hermes Birkin handbag — the reality is that having wealth doesn’t enable the kind of luxury spending that most people imagine.
How can this be?
There are two reasons.
The first is that it takes an enormous amount of wealth to duplicate what you can do with a paycheck, even a humble one.
Suppose, for instance, your job pays $20,000 a year. No one would call this luxury living. Yet if you inherited money today, you’d need about $1 million to provide that income in dividends. The S&P 500 is currently yielding less than 2 percent. It’s a struggle to squeeze more income from a portfolio.
Think of it. You’d be a millionaire scraping along, living an unenviable dividend-to-dividend existence. (Just don’t expect sympathy from anyone.)
Let me put this in real down-to-earth terms. The annual dividend income from that $1 million would cover the payments on a Bentley for less than six months. The better news is that it would buy about 20 pairs of Jimmy Choo shoes, a few more if you buy only sneakers and sandals.
What happens if you spend more?
“Yes,” some will say, “but surely you can spend more than your dividends.” Or you can invest in stocks that pay greater dividends, right? Sorry, it doesn’t work that way. Take more cash and you could run out of money.
Using the Monte Carlo analysis tool on the portfolio visualizer website, I found that a starting withdrawal of $50,000 a year, adjusted annually for inflation, had a 32 percent chance of depletion in 40 years. Raise the income rate to $80,000 (for reasons I’ll explain in a moment) and it gets a lot worse. You’ve got a 51 percent chance of being broke in only 23 years.
This would be seriously inconvenient for younger inheritors. They would end up like Wilson in W. Somerset Maugham’s “The Lotus Eater.”
You can get a better idea from my Life of Riley Index. Every year I estimate how much you’d need in financial assets to produce an annual dividend and interest income greater than 75 percent of all American households. Last year, that figure was $82,201. The yield on a 50/50 stocks/bonds portfolio was 2.28 percent. So you would need a whopping $3.6 million portfolio to sustain a merely comfortable lifestyle.
A more subtle reason a million doesn’t go that far
The second reason wealth won’t do as much as most people think is more subtle. You aren’t done with spending after you’ve paid for that coveted luxury doodad. Most of the things we own have some level of spending associated with owning.
—You can’t own and drive a car, for instance, without paying for insurance, service, repairs, fuel and taxes.
—You can’t own a house without paying taxes, insurance, utilities, service expenses and repairs. A rough rule-of-thumb for the operating expenses of a house is about 5 percent of its value, every year. A $250,000 house, for instance, would cost about $12,500 a year to support. So after you paid cash, your remaining $750,000 would produce about $15,000 in pre-tax dividends, or about $12,750, after the 15 percent tax on dividends.
According to the Federal Reserve Bank of St. Louis the median sales price of a home in the United States was $317,400 in the last quarter of 2018. So a million dollar inheritance would buy and support something less than glitzy. In Dallas, according to Zillow, the income from your $1 million won’t even support the median rent of $1,494 a month.
The bottom line here is simple. You can spend a dollar only once. Once it’s spent, it’s gone. It no longer earns money because it isn’t invested. Worse, what you paid may have committed you to spending still more money because your new luxury purchase costs money to maintain.
But look on the bright side. Your day job is a lot more valuable than you thought!
Keep it.
Related columns:
Scott Burns, “Huzzah! Living the Life of Riley Costs $1 Million Less,” 7/22/2018 https://scottburns.com/living-the-life-of-riley/
Sources and References:
Brittany De Lea, “Get ready for one of the greatest wealth transfers in history,” 3/13/2018 https://nypost.com/2018/03/13/get-ready-for-one-of-the-greatest-wealth-transfers-in-history/
Car and Driver: Bentley prices: https://www.caranddriver.com/bentley
Jimmy Choo shoes: https://us.jimmychoo.com/en/women/shoes/?gclid=EAIaIQobChMIzYieiMzX4QIVrfbjBx2HDgCtEAAYASAAEgJsLfD_BwE
Top 10 Most Expensive Handbags of 2019: From Hermes to Mouawad: https://financesonline.com/top-10-most-expensive-handbags-in-the-world-louie-vuitton-diamonds-crocodile-skin/
Portfolio Visualizer Monte Carlo simulation: https://www.portfoliovisualizer.com/monte-carlo-simulation
Wikipedia: The Lotus Eater. https://en.wikipedia.org/wiki/The_Lotus_Eater
Federal Reserve Bank of St. Louis, Median Sales Price of Houses Sold for the United States: https://fred.stlouisfed.org/series/MSPUS
Zillow: Dallas Home Prices & Values: https://www.zillow.com/dallas-tx/home-values/
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by bruce mars from Pexels
(c) Scott Burns, 2019