MONEY CLINIC | Would a R700 000 investment yield enough interest to use and live off on?

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Investing most of your money for interest presents its own risks, especially if you plan to do this for the long-term.
Investing most of your money for interest presents its own risks, especially if you plan to do this for the long-term.
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A Fin24 reader looking to invest a R700 000 lump sum, wants to know if it's possible that the interest will be enough to grow, use and live off on the interest. He writes: 

I want to invest a R700 000 lump sum, part to grow and use and a portion to live on the interest. I need R4 000 pm. Would this be possible?  

Brett Mackay, Investment Consultant at 10X Investments, responds:

We are unable to give you a definitive answer without doing a full 'financial needs' analysis to determine the option most suitable for your needs. Our response below is, therefore, for illustrative purposes only. 

To answer your question, we must determine the lump sum required to generate a reliable interest income of R4 000 per month. Whatever is left can then invested for long-term growth, for example in low-cost high-equity unit trust fund. 

To calculate the lump sum required to generate R4 000 pm (or R48 000 per year), we divide the R48 000 by the interest rate you are likely to earn. 

For example, on a one-month fixed deposit, you are unlikely to earn much more than 3% pa at present. R48 000 divided by 3% means you would require a lump sum of R1.6 million to earn the level of income, which is much more than you have. 

That is just one scenario, though. The rate of interest you earn depends on numerous factors, such as the amount of money being invested, your age, the investment term, the risk-rating of the provider, and whether the return is linked to the market performance of an underlying instrument. 

As is the general rule when it comes to investing, the more risk you assume, the higher your potential reward. If you want immediate access to your money, you will receive a lower interest rate than if you agree to a fixed investment term, say one month, or one year, or even five years. In return for receiving a higher interest rate now, you assume the risk that inflation (interest rates) rises in the future, or that you may need to access the money for an emergency and incur an early withdrawal penalty. 

Money market funds (a type of collective scheme) usually offer higher returns than a bank deposit, but the return, or your capital, is not guaranteed (although the underlying risks are still quite low). 

Alternatively, if you agree to lock up your money for five years, you could earn as much as 8% p.a. at present with some banks. (Banks publish their fixed deposit interest rates online, so you can shop around for the best deal.) In that scenario, you would earn R4 000 pm on a R600 000 lump-sum investment, and still have R100 000 left to invest for long-term growth. 

So, to answer your question, it is possible if you are willing to assume the risk of locking your money up for five years, and you accept that only a relatively small part of your lump sum will be invested for growth.  

But, as a word of caution, investing most of your money for interest presents its own risks, especially if you plan to do this for the long-term. Living off interest income creates the illusion that the underlying capital is being preserved when, in truth, the purchasing power of the interest you receive and the capital you invest is being steadily eroded by inflation. The income you draw will afford you less every year and you may eventually have to access the capital to preserve your lifestyle. This will further accelerate the depletion of your savings. 

One way to mitigate these risks is to invest in an inflation-linked, guaranteed annuity. Such annuities currently pay a higher return (depending on your age and the annuity you choose).

For example, if you are 60 years old, you could buy an annuity for R500 000 that pays roughly R4 000 pm, increasing at 5% p.a., which, hopefully, will be enough to cover annual inflation. You then still have R200 000 left over to invest for growth. Your main risk is that you lose control over the R500 000, and that your bequests are limited to the portion you invested for growth.  

*Questions may be edited for brevity and clarity.

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