How to invest 300k for a 40 year old who needs to live off of it.

My mother recently won a lawsuit. She will have about 300k to invest. She will be able to work part time (25k annually?) and will need about another 25k annually to live on. An 8% return on her money seems reasonable, which allows the interest to make up the missing 25k, but this is best case, and doesn't allow for compounding the interest. She may need more/make less and need to dip into the principle to make ends meet. I know this is a tough spot to be in and there isn't a "winning" answer, but I'd like to know, in general terms, what a solid plan would be. Here is what I'm thinking so far:

1) Keep 50k (2 years of expenses) in an very liquid state - maybe a high interest (4+%) savings account with monthly allocations to a checking account. 2) Ladder 150k in safe investments - CDs, T-Bills, etc., reinvesting as they mature. 3) Invest the remaining 100k in a long term equity investment - Probably split across a few Index Funds.

I'm hoping that by keeping the 50k relatively liquid I can avoid her watching her equity account, allowing it to ride out dips in the market and letting the investment grow over (hopefully) a minimum of 2 years.

I don't have any practical experience with this, but these are the things I've picked up along the way. I'd appreciate input from someone a little more experienced. She is a little nervous about just handing it to an advisor and letting them have their way.

Thanks!

-Ryan

Reply to
gotcode
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The important aspect of this is not having a down year in the beginning.

A few ideas:

start with 5 years in cash- this gives the other portion longer to compound and ride out a market dip. of the 5 years in cash, put 2 months in CDs as you suggested, with the other 3 years in something indexed to inflation (IMO the biggest risk with 5 years of cash is high inflation at some point).

invest remaining in equities and withdraw in up years only. If this account is taxable, consider favorable tax treatment of dividends.

for 50k in annual income, is there a need to increase this income over time (inflation)? for the 50k in annual income, is there a way to project expenses going away over time (like a mortgage, car payment or other debt)? how long does the 50k in income stream need to be maintained? When can she collect Social Security? If you know a SS payment is coming in 20-25 years, consider making sure the 300k lasts until SS kicks in. Or invest the 300k more aggressively because you know SS behaves like a cash/bond investment.

Reply to
jIM

How long do you envision this being the situation? If it's permanent, or for the forseeable future, you're going to need to think about inflation. If you're looking for an 8% REAL return (i.e. after inflation), you're looking at a 100% stock portfolio. The average real return on the S&P 500 from 1987-present is 8.33%. I don't need to tell you how volatile stocks are.

There's a rule of thumb in financial planning called the Rule of 25. It says that to earn $1 from your investments, you need $25 invested. The Rule roughly accounts for inflation. Stated another way, it says that you can expect a 4% real return on your investments. The Rule of

25 is pretty conservative.

On the plus side, your mom may need less money than she thinks. The money earned from investments is not subject to payroll taxes. In addition, qualified dividends and long-term capital gains are taxed at a rate lower than earned income. If your mother has earned income, she'll be able to start moving money in to a tax shelter, like an IRA or 401k. That will also lessen the tax burden, further reducing her income requirements.

--Bill

Reply to
woessner

I am not usually a pessimist, but I think what you are asking is probably not going to turn out like you hope.

$25K a year on $300K is 8.33% average annual return NOT accounting for taxes or inflation (two of the most important things you should be considering). Remember both the investment and her earnings will be taxed. Her earnings should rise with inflation, but her investment will not. The return you need to ensure that your mother has $50k in SPENDING POWER every year is much higher and probably not even attainable if she is invested 100% in equities. 20 years from now she will need over $45K annually to buy the same things that $25K will buy today (assuming 3% inflation).

Furthermore, placing $50K in cash and another $150K in CD and t-bills will reduce risk (which sounds like the appropriate thing to do, if your Mother will sleep uneasy invested totally in equities) but means that 2/3 of your principal is invested in vehicles that are almost guaranteed not to produce your target return. 4% - 6% is common for these investments which means the remaining $100K has to earn around

15% to get a total return of 8.33% and you will still be losing ground to inflation and taxes every year.

Of course, as someone else already said, in 23-25 years SSI may supplement your mother's income but if she retires the benefits will not even replace the $25K she was earning at work. She will need even more support from the lawsuit money than before.

In conclusion, you and your Mother should seriously reevaluate your expectations for this money. Also, while there are many posters on this site that have educated themselves thoroughly enough that they are more than capable of handling their investments without paying a financial planner, I highly recommend you consult one (fee based, not commisions). You are new to this world and have had a large sum of money "dumped in your lap." The consequences of learning-as-you-go are simply too great.

Good luck

Reply to
kastnna

You need to first understand risk vs return. 5% (or so) is the current risk-free rate. The stock market may return 8% moving forward, but with a risk (standard deviation of return) of over 10%.

Draw a bell shaped curve. Then a vertical line down the center. At the bottom, label 8%. Then strike a vertical line at -2%, and another at

+18%. 2/3 of the time the return will be here, between -2 and +18. 1/6 of the time it will be worse than -2. (Sorry I can't post a picture)

I recall -23% as the return in 2002. In such a year, you will lose 15%+ depending on your cash/stock mix, plus the 8% withdrawal for a 20-25% down year. As others have stated, the number for retirement planning is

4% for the first year withdrawal rate. This allows for increases for inflation, and takes into account the risk each year of a negative return. If nothing else, get a spreadsheet and pull up the returns for 2000-2006 to see how your plan would survive such a period. The people here have your best interest (no pun intended) in mind, and nothing to lose by telling you their opinion. Consensus here will be that 8% is not reasonable. Not one person (who is a regular poster) will say it is. 5% is pushing your luck for a 40 year old, unless family will step in to help.

JOE

Reply to
joetaxpayer

I believe this is incorrect. Her investment will not be taxed. Insurance settlements are non-taxable events. Only the earnings will be taxed.

The remainder of Kastna's post is spot on. The mother definitely needs to rethink her income needs. Additionally, this is a situation that screams for professional advice.

Elizabeth Richardson

Reply to
Elizabeth Richardson

Elizabeth,

Thanks. I did not know that settlements weren't taxable. I'll have to file that one away.

Reply to
kastnna

Elizabeth,

I think I was not clear. I meant the earnings on the 300K would be taxed every year. So she would need more than 8.33% to have $25K in spendable dollars.

Is this correct or am I still missing something.

Thanks

Reply to
kastnna

Thank you all for your input. I think that at this point, I'm going to seek the advice of a professional. I clearly don't know enough about what I'm doing to accept liability for her financial future. I will also stress to her the reality of the situation - that although this is "a lot" of money, it isn't going to allow her to live in the lifestyle she was accustomed to when she was working full-time. Maybe I can convince her that this is only a windfall in terms of catching up her retirement account to where it should have been if she had been saving all those years.

Thank you all!

-Ryan

Reply to
gotcode

May I stress the point, choose a fee-based pro, not commission based. And if he suggests any kind of annuity, walk away, and seek out someone else. The group here would be more than happy to comment on whatever the pro tells you before you move forward. Good luck to you. JOE

Reply to
joetaxpayer

You might try a financial site like Fidelity or Vanguard and look at their "income" products. This is an issue shared by retirees. Income products reduce risk losing principal while generating higher returns. These include annuities, bonds, high dividend blue-chip stocks.

Reply to
rick++

What's so wrong with annuities for an older investor such that the suggestion of them is worthy of a litmus test?

I honestly don't much about annuities other than I know someone in her

70's that has at least one somewhere who is generally pretty sharp with her money.

Best Regards,

-- Todd H.

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Reply to
Todd H.

Yes, all the earnings would be taxable, unless, of course, she were to invest in something like muni bonds, when she gives up the earnings she so desperately needs. The MORE than 8.33% escalates if she spends any of the $300k principal.

Elizabeth Richardson

Reply to
Elizabeth Richardson

The biggest problem is probably that when one says "annuities" there are many different things that can mean. Mainly, two variables implying four different types - deferred vs. immediate and variable versus fixed (the latter potentially inflation adjusted).

A traditional pension, once it starts paying out, is basically an immediate fixed annuity. And potentially a very useful tool for a risk-averse investor who needs a predictable cashflow (ie. to live on).

Unfortunately, the thing folks need to be very wary of - the thing which is often pushed (ie. sold very hard) is the deferred variable annuity. I'm much harder pressed to come up with scenarios where a deferred VA is the right choice. Sadly, they are sold all the time and very often to folks for whom they are entirely innapropriate.

Reply to
BreadWithSpam

A way to meet your mother's income objective is to invest in a portfolio of small value stocks. On average, the rate of return of such a portfolio has been 12.13 percent in REAL terms during the last 78 yrs (see

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course, the down side is that you need to accept relatively volatilereturns (for instance., you may get a return of 60 percent one year andminus 20 percent the next year)This should provide the desired income, even after accounting for taxes.

Reply to
Jose Bailen

ANother thing to factor is how many years until your mom gets social security. That might generate half of the income she may need, allowing you to invest the settlement more aggressively or help take counteract inflation.

Reply to
rick++

ANother thing to factor is how many years until your mom gets social security. That might generate half of the income she may need, allowing you to invest the settlement more aggressively or help take counteract inflation.

Reply to
rick++

-Will

Reply to
Will Trice

Elizabeth, I'm afraid you are incorrect. First, the OP did not say that it was a settlement, he said his mother "won" a lawsuit. Second, there is no such rule that "insurance settlements are non-taxable events." It doesn't matter who pays, it matters what the money is being paid to compensate, ie, general damages? special damages? punitive damages? Each of them have different tax treatment, and it also depends on which circuit court of appeal jurisdiction the OP lives in since the federal appellate courts are split on some of these issues.

It may be true that the earnings in a structured settlement paid directly to the plaintiff as part of a settlement may not be taxable, but that does not mean that all insurance settlements are non taxable.

The bottom line is there are a lot of issues involved that have to be reviewed and the OP needs to seek a tax professional who understands the tax implications of lawsuit damage awards and settlements.

Reply to
emailforian

The results of the Monte Carlo simulation are too pessimistic. An exercise I made some time ago is to download the historical data supporting these results (they are available at the Ken French website:

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for 30 yrs periods, the lowest average real rate of return of thetypical small cap value portfolio was 8.1 percent (that was the 30-yrperiod from 1946 to 1975) -the highest was the 30-yr period that endedin 1961-. There are 49 30-year period observations -all the 30 yearperiods starting the one that ended in 1956, so the results arestatistically significant. This webpage at Harvard describes the caveats of the Monte Carlo simulation:
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"A few very important caveats about these equations:

They should not be used with small n. The assumptions upon which they are based break down when n is less than 30.

Similarly, they should not be used with probabilities that are extremely near zero or one unless a large number of samples are drawn. One rule of thumb is that the estimate should be based on at least 5 trials with both outcomes- so if you are estimating the probability of an event that has a very low true probability, you may have to take a large number of samples before you have any evidence at all that the probability is non-zero- but if you happen to draw a positive sample in one of the first trials and stop soon thereafter, your probability estimate may be wildly high.

These equations are pessimistic. Assumming that the previous two conditions are met, they generally give margins of errors that are too wide (or suggest that you should perform more trials than you really need to). Personally, this is the direction I prefer to err in- I would rather believe that my estimate is less accurate than it is, instead of thinking that it is more accurate than the facts would support. However, if you are trying to perform the absolute minimum number of trials necessary to achieve a given level of confidence, you may wish to find a tighter bound.

Reply to
Jose Bailen

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