Myth of the Wealthy Millionaire

The last decade (2000-2010) has been one of the most tumultuous periods in the history of financial markets.  We had the technology bust, followed by the housing bust, followed by the stock market bust, followed by the commodities bust.  Many investors lost a significant portion of their savings in one or more of these debacles.

As our politicians debate measures to shrink our budget deficits, the rich usually become a bone of contention.  Folks on the right side of the political spectrum usually push for tax cuts, while those on the left typically call for higher taxes on the wealthy.   But what is wealthy?  Are the rich living lavish lifestyles while the poor suffer?

One common definition of wealth is the term millionaire.  The term is often tossed around when money is discussed.  Further, game shows abound with titles like “Who Wants to be a Millionaire”, “The Million Dollar Money Drop” and top selling books have titles like “The Millionaire Next Door”.   Clearly, amassing a million dollars is a common measure of success.  Let’s take a look at the income a millionaire would have at her/his disposal under various asset allocations.

To keep things simple, we have chosen a simple 50/50 stock/bond split, using low cost Vanguard mutual funds (VHGEX and VBTIX) as the most basic allocation.  We have also used recommended allocations/mutual funds from Morningstar.

The approximate current yield of each allocation is as follows:

The math is easy from here.  On a million dollar, conservative portfolio, an investor would receive a pre-tax income of roughly $28,500.  An “aggressive” investor would receive a measly $14,500 in income.  After taxes, a millionaire living off of the income of her/his portfolio, is receiving poverty levels of income.  And this doesn’t take into account advisor fees, which may actually leave the investor with negative income as shown in the last two columns.

Now, a couple of caveats.  First, it is said that an investor can often count on capital gains to add “income” to a portfolio.  This may have been true in certain periods in the past, and it may be true again in the future, but it wasn’t true over the past decade.  Whether you use 12/31/1999 to 12/31/2009, or 12/31/2000 to 12/31/2010, S&P 500 returns were negative (-16.1% for the former, and -7.7% for the latter).  So, an investor cannot count on capital gains.  In fact, to protect the principal, lower risk assets must be chosen, and this almost always means relatively low yields.  Secondly, a millionaire can consume principal to supplement the income from dividends and interest.  This is almost certainly the case today, as negligible rates, held down by the Fed, penalize those living on accumulated assets to the benefit of the financial sector.  So, in a sense, these “millionaires” are already being taxed to subsidize Wall Street.  Of course, any principal consumed has a large, negative impact on future income.  Using the 2.85% annual yield as a base, the table below shows how many years before the money runs out at various levels of consumption both with and without an advisory fee.

For someone aged 65, just retiring with $1 million in assets and with a life expectancy of 83 years, the table shows that, because 50% of these folks are expected to live beyond 83 years, more than half will run out of money if they take as much as $75,000 per year.  And, a significant percentage would run out before the end of their lives at $60,000. As is evident, most of these so called “wealthy” are clearly depending on social security and this places such folks solidly in the middle of America’s dwindling middle class, not at the upper end.  Thirdly, this assumes that we don’t suffer yet another burst bubble where even high quality assets get decimated.  In this case, the number of years to a $0 balance is even shorter.

It is sad truth of today’s world that many Americans find it difficult just to make ends meet.  Saving significant sums of money to invest is even harder.   For those lucky few that have been able to either save or inherit a million dollars, it would seem that security has been assured.  Unfortunately, this is not the case.  Today’s low interest rates are destroying the incomes of people living off of past savings (never mind what they are doing to underfunded pension plans!).   For the small percentage lucky enough to retain a million dollars in assets, the reality is not as bright as it would seem.

Let’s hope that a tax assault doesn’t  further dismantle the American Dream.

Matt Marcewicz

Robert Barone, Ph.D.

February 10, 2010