Investment Returns Versus Active Income: When Work No Longer Matters

At some stage in your investing journey, you may experience a situation where your investment returns surpass your active income (non-investment income). The first time this happens, you may feel excited as you imagine the possibilities. But you likely won't quit your job just in case it was a fluke.

However, after several years of your investment returns surpassing your active income, you will develop a lot more courage to do something new.

Perhaps you might finally ask for that well-deserved sabbatical without fear of your year-end bonus getting slashed. Or maybe you'll have the guts to start severance negotiation talks so you can pursue a new career.

The power of compound annual returns is why you should save aggressively and invest for the long term. It is also why you need to think twice about splurging on big-ticket items like a car you don't really need.

That $40,000 car you bought 10 years ago would be worth around $150,000 today if it was invested in the S&P 500.

Differentiate Between Investment Returns And Investment Income

Since I began working in finance in 1999, I've always had my mind set on generating investment income to eventually cover my desired living expenses. Getting into work at 5:30 am and leaving after 7:00 pm every day in a high-pressured environment for decades was not sustainable.

When I left in 2012, I had about $80,000 a year in total investment income of a total net worth of about $3 million. Back then, I dared not count on investment returns to pay for my lifestyle. We had just gone through a gut-wrenching recession and there was a chance we could go right back.

Further, counting on investment returns to fund expenses would require withdrawing principal, which I didn't want to do. A decent portion of my investments was in growth stocks that produced no dividends. I was also still in my mid-30s and believed there was further upside to risk assets.

Therefore, I wrote the post, The Ideal Withdrawal Rate In Retirement Touches No Principal. The post helped motivate me to live frugally. I wanted all of my investments to continue compounding during an emerging bull market.

I've followed this strategy since leaving work in 2012. As a result, my original retirement nest egg has grown and so has my investment income. Now it might be time to change strategies.

Time To Live Off Investment Principal?

After a 12-year bull run, the easy money has already been made. Valuations are expensive, the Fed plans to taper, and we haven't had a 10% correction in a while, until now!

Even Vanguard is estimating only a 4.02% annual return for U.S. stocks over the next 10 years. The estimate seems low, but it could certainly happen, especially if there's another bear market during this time.

Therefore, it might make sense to finally cash in some of the gains to live a better life. If a stock market crash does happen, you'll be pleased to have utilized your investment returns for things and experiences. Dying with too much money would be such a shame.

Instead of just arbitrarily selling off investments to fund your retirement lifestyle, you could simply raise your safe withdrawal rate. Spent more money so you can enjoy your returns instead of lose it in an inevitable correction.

Case Study Of Living Off Investment Returns

Let's say you believe in the Financial Samurai Safe Withdrawal Rate Formula = 10-year bond yield X 80%. As a retiree, your average withdrawal rate over the past five years was 1.5% to ensure that you didn't draw down any principal. With a $3 million portfolio, you were living off $45,000 a year in gross income.

However, during these five years, your investments appreciated from $3 million to $5 million. They did so due to a 10.8% compound annual return. If you continue to withdraw at 1.5%, you will be able to live off $75,000 a year in gross income.

$75,000 is more than enough income to live a comfortable retirement lifestyle. You don't need that much money. But you're older now and feel like you might die with too much.

Given you were confident enough to retire with $3 million, the past five years feel like you've won five consecutive lotteries.

Not only have you been able to do whatever you've wanted for the last five years, but you're also $2 million richer! With five years less life to cover for, your desire to spend more has increased.

The YOLO economy is calling your name.

Cost To Fund New Initiatives

First, you want to use your lottery winnings to superfund four 529 plans to the amount of $300,000. The idea of using a 529 plan for generational wealth transfer purposes sounds like a no-brainer.

Next, you want to rent the Symphony Of The Seas Ultimate Family Suite for an around-the-world cruise. The cost? $20,000 a week for 10 weeks!

Although $200,000 is a lot of money, the suite is 1,346 square feet and large enough to comfortably accommodate your four grandkids. It would be the time of all your lives!

The total cost to fund these two items is $500,000, for a one-time withdrawal rate of 10% ($500K / $5 Million). If you consider taxes, then perhaps you really need to withdraw closer to $700,000. But let's just use $500,000 for simplicity's sake.

After the adventure is over, you're now left with $4.5 million, or still $1.5 million more than you need.

You decide after spending so much money so quickly, you should take a break and go back to normal. Therefore, you adopt the FS safe withdrawal rate formula again and withdraw at 1.1% since the 10-year bond yield has declined.

With $4.5 million left, you get to live off $49,500, which is still $4,500 a year more than you were living off five years ago. All hail the benefits of a glorious bull market!

At What Point Does Work No Longer Matter Due To Investment Returns?

As I transition back to retirement by 2023, I've been trying to justify my decision to no longer work so much. As a father of two young children, not working feels like a sin.

However, my investment returns have been greater than my active income returns for the majority of years since 2012. In addition, the active income I do make doesn't do much to stem any losses.

For example, let's say I lose 10% on a $5 million portfolio. That's a $500,000 loss. Even if I worked really hard for several months to make $50,000 online, I'd still be down $450,000. Losing $450,000 feels the same as losing $500,000. Terrible. Therefore, spending precious time to make $50,000 would make the situation even worse.

On the flip side, let's say I return 20% on a $5 million portfolio in one year. That's a $1,000,000 gain. Even if I take on some consulting projects to make $100,000, a $1,100,000 gain doesn't change our lifestyles one bit. We comfortably live on much less each year.

Therefore, there has to be some sort of crossover point where spending any amount of time making active income becomes a waste of time. The only way you would spend time making active income is if you truly loved your work. You don't care how little you get paid because you'd do it for free.

If you're a regular reader of Financial Samurai, I think you can tell I love to write and share my thoughts. Writing posts like, If You Want To Naturally Be Nicer, Get Richer, isn't going to make me money. But human behavior is an interesting topic to me so I write about it anyway.

The Investment Returns Crossover Point

I believe there are two conditions an investor must achieve before they can drop active income due to investment returns. Again, we are differentiating between investment returns and investment income. Once you generate enough investment income to cover your desired lifestyle, you can leave immediately.

Condition #1: At Least Three Years Of Outperformance

If your investment returns are greater than your active income for at least three years in a row or four years out of the last five years, I think you have the green light to take things down a notch.

Three years helps minimize the chances that your investment returns are not a fluke. And given bear markets (-20% sell-offs) tend to happen every 3.5-4 years, I use the benchmark of four years out of five years to account for a couple of bad years.

If your investment returns are greater than your active income for five years in a row or five out of the last seven years, you should be able to completely retire if you want to. Here is my latest stock market forecast and housing market forecast. Unfortunately, 2022 has turned out to be a terrible year given the Fed has aggressively increased rates.

Condition #2: Investments Equal To At Least 10X Your Annual Active Income

In order for your investment returns to generate more than your active income for three years or longer, you likely need a sizable investment portfolio that is 10X or greater than your annual active income. For example, if you make $100,000 a year, you would likely need at least a $1 million portfolio for a chance to generate $101,000+.

To generate $101,000 in investment returns on a $1 million portfolio would require a 10.1% return. If your entire portfolio is in the S&P 500 and the S&P 500 returns its historical average of 10.2%, then you've got a decent chance of outperforming your active income.

However, if Vanguard's lower return assumptions for stocks and bonds come true, then you will likely need an investment portfolio at least 20X your annual income until you no longer have to work. 20X your annual income is a key metric because it is my recommended net worth target to shoot for before retiring.

Using a multiple of income is better because it keeps you motivated to save and invest more as you make more money. We all tend to make more the longer we work. Further, using a multiple of income is preferable to using a multiple of expenses because it also keeps you honest. You can't take a shortcut to financial freedom by slashing your expenses.

Once these two conditions are met, you should be able to reduce your work hours or eliminate them altogether. Further, these two conditions are scalable, no matter how much money you have.

How Long Will It Take Investment Returns To Surpass Active Income?

The length of time it will take your investment returns to surpass your active income will depend on your saving rate and your rate of return. Obviously, the higher your saving rate and rate of return, the greater your chance of succeeding.

Given I believe your capital needs to reach about 10X your annual gross income in order for your investment returns to regularly surpass your active income, let's do some math.

Example #1: 20% Saving Rate

If you start with nothing and save 20% of your annual gross income each year, in 18 years at a 10% compound annual return, you will have accumulated 10X your annual income. In the 19th year, if you continue to get a 10% return, your investment return will have surpassed your static annual income.

If your rate of return is only 5%, then you will accumulate 10X your annual income in 25 years. If a 5% rate of return continues, then unfortunately, you will have to save and work for 36 years to finally see your investment returns surpass your annual income.

Example #2: 50% Saving Rate

If you start with nothing and save 50% of your annual gross income each year, in 11 years at a 10% compound annual return, you will have accumulated a little more than 10X your annual income. In the 12th year, if you continue to get a 10% return, your investment return will surpass your static annual income.

If your rate of return is only 5%, then you will accumulate 10X your annual income in 14 years. If a 5% rate of return continues, then you will have to save and work for 22 years to finally see your investment returns surpass your annual income.

The Likely Time Range

Saving 20% of your annual gross income each year really is the minimum amount I recommend everyone shoot for. Ideally, you will eventually make enough money to get to a 50% saving rate.

With a 20% – 50% saving rate and a 5% – 10% annual return assumption, it will likely take between 11 – 25 years until your investment returns steadily surpass your active income. Of course, if your income declines towards the end, then you can achieve this milestone sooner as well.

For me, it took about 15 years to regularly earn a greater return from my investments than my last year of working.

Thankfully, we can all buy Treasury bonds now and earn over a 4.4% risk-free return nowadays. That's pretty enticing, especially if you are withdrawing in retirement at less than 4%.

Living Off Investment Income May Be Harder In Normal Times

Generating enough investment income to cover your desired living expenses may be harder than generating high enough investment returns to cover your living expenses.

For one thing, you need to accumulate a lot more capital given interest rates are lower. You've also got to be disciplined enough to not touch principal. Finally, you may have to shun many growth stocks and equity real estate investments that produce no income, but may provide a greater return.

In contrast, if there is a raging bull market, then living off investment returns may be much easier. You won't need as much capital to fund your lifestyle if your $1 million portfolio is returning 25% a year. But to generate $250,000 a year in investment income will require a $12.5 million portfolio with a 2% yield.

The reality is investment income and investment returns are intricately tied together. The logical thing many people do who no longer want to work is change their investment composition towards less risky, more stable, income-producing investments once they've reached their ideal number for retirement.

For example, ~50% of my net worth is in real estate versus ~35% in stocks. I want less volatility and more passive income. I've also got another 5% or so in individual AA-rated municipal bonds. The rest of my net worth is in private equity and private real estate investments.

When I was in my 20s and 30s, stocks accounted for 50% – 90% of my net worth. Losing 30% of my net worth in six months was OK. I could easily make up for my losses with my income. Today, not so much. Time is much more precious now that I'm older.

There Is A Level Of Capital Where Nothing Matters

Let me end by sharing a warning. There is a level of capital where you may lose all motivation to do anything.

In 2012, I was starting to get apathetic about making more money, which is one of the reasons why I left banking. At the time, my net worth equaled about 10X annual income and 40X annual expenses.

After such a long and relentless bull market, my apathy has returned. Yes, there were two massive spikes of motivation after each of our kids were born. But it has settled down now. If our investment returns were poor since 2012, I would be feeling the opposite.

Once your net worth is over 20X your annual income or 50X your annual expenses, apathy sets in. Once your net worth gets to over 40X your annual income or 100X your annual expenses, that's when you start completely checking out. You may start constantly thinking to yourself, “F this BS!”

Therefore, if you want to stay motivated, you might ironically have to keep inflating your lifestyle! It's either that or give more money away. You can always do both.

If the strong returns in risk assets continue, eventually, productivity will decline. In that case, the only people left to do the work will be non-investors and new graduates.

I'd love to hear your thoughts on how you would use investment returns as a gauge for work effort. With investment returns so strong for so many years are you getting demotivated to work as well?

Generating Greater Investment Returns With Real Estate

The combination of rising rents and rising capital values is a very powerful wealth-builder over time. As a result, real estate is my favorite asset class to build wealth. Not only is real estate less volatile, there are great tax benefits as well.

Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore. 

Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the easiest way to gain real estate exposure. 

CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. Due to positive demographics, growth rates tend to be higher as well. If you have a lot more capital, you can build you own diversified real estate portfolio. 

I have so far invested $810,000 in real estate crowdfunding. Currently, my real estate holdings generate about $150,000 a year in passive/semi-passive income so we can live free.

For more personal finance content, join 50,000+ others and subscribe to my free weekly newsletter. We'll talk about investment returns, spending money wisely, and more since 2009. Let's get your investment returns to surpass your active income once and for all!

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98 thoughts on “Investment Returns Versus Active Income: When Work No Longer Matters”

  1. Thank you. This information is very useful. We’re 41, 2M mostly in PE and 400k one income. It seems silly for the other parent to work and be taxed at 50+%. Fortunately this has given us time to pursue more lucrative and deferred taxed opportunities. Tax policy incentivizes quitting.

  2. Sam: I am a 52 yrs Old Man. I have $40,000 in 401K, I am way behind on retirement. What can I do. I earn $65,000 Yr and am running out of time. Please advise.

    1. Reaching retirement is a 3 legged stool:

      -Save more
      -Spend less
      -Work longer

      Unfortunately there is no magic formula here and taking on excessive amounts of risk to catch up is precarious, to say the least. Perhaps coming up with a financial plan so you have a roadmap of what you need to do to achieve your goals would be a good start.

  3. At some point in your life you come to the realization that time is short. You blink and your kids are no longer children. Not to mention your health is a precious blessing.

    While investing and transferring wealth to your future generations is an admirable goal, no amount of money can make up for the time you spend with them. There’s some balance to be struck between preparing for tomorrow and enjoying the present.

  4. One way to prevent your income from becoming irrelevant is to compound it alongside your investments. This can be done by diversifying take-home income sources as well as growth of an income source ie. business growth, real estate rental increases, stock dividend increases via splits, enhancing income tax deferral/deductions, geographic arbitrage, etc.

    My active income now, halfway thru my career, is 10 fold what it was at the start of my career. It still matters as it ups the ante towards the goal of a 25x income NW, albeit less than it once did relative to NW appreciation thru passive income/asset appreciation. My NW is currently over 100x my 6 figure starter income, but it is not yet over 25x my current 7 figure annual active income.

  5. Hi Sam
    I’ve been reading your blog for almost 5 years now and have learned so much. Thanks for everything !

    Question – Should portfolio withdrawals be included in the 20x income in a semi-retired household? My husband received a considerable sum about 14 years ago (tragic circumstances) and since then we’ve continued to work, but now want to focus on developing income doing what we love. A few years ago he quit his job to start something new and now that his income is up to a healthy amount, I am ready to leave my job and do the same.

    Neither of us want to retire in the traditional sense; we just want the freedom to make less money while perusing our interests. We live in an expensive city in Canada and withdraw about 40k annually from our portfolio. Our income, including our rental property, the portfolio withdrawal, and day jobs, is around 180-190K. Net worth is sitting around 3.6-4m including our principal residence which puts us at 20x income. Our net worth growth has also exceeded our income for the last 5 years.

    I’m taking the plunge either way, but it I’ve never gone without a paycheck! it’s quite a bizarre experience for me. We have a toddler and another on the way, and thankfully were also able to save up a year of expenses in cash, but giving up a solid paycheck with two young kids sometimes keeps me up at night. We are both mid 30’s.


    1. Hi Kevin,

      Nice to hear from you. Portfolio withdrawals shouldn’t be considered income. But portfolio income should be considered income (passive income).

      It sounds like you guys are living relatively frugally for your net worth. So I wouldn’t have any problems taking a leap of faith and doing something else you enjoy doing that doesn’t pay as much.

      Further, to be able to spend more time with your little ones before they go to school full-time is really a blessing. Hard work, but the time goes by quick. I just dropped off my 4 yo at preschool. I asked him whether he wanted to walk around the block and see some garage doors before going in and spend more time with me, and he declined. He was so excited to go to school!



  6. Sam: when you say 20x active income, I assume you mean 20x pretax wage/income too? Also a friend recently reminds me that my so-called “net assets” is still subject to ~30% tax when I sell them, so even our liquid portfolio is ~$10M, it’s really $7M because we have to pay 20% long term capital gain, plus ~10% California income tax.

    Also our $10M was merely ~$5M 3 years ago thanks to the recent monetary policy. For people who won’t retire in 10-20 years it probably doesn’t matter, but since we’re planning to retire in 1-4 years, I feel at least we need to set aside 2-3 years cash for living expense so we don’t have to sell if the market falls 40%.

  7. I’m experiencing a bit of this apathy already and I don’t have those numbers. I can’t imagine what it will be like when our investment values are high enough to really not care.

    I think it really does come down to workers getting more wise to the notion of ‘why am I killing myself for these people?’ at work. I do good work, and we’re short staffed like everyone else. My current apathy stems from the notion of, what are they going to do, fire me? Someone else will certainly want me if that happens. I can’t be bothered to care too much. I’ll just keep doing my job and investing for our future.

  8. Hi Sam, does your savings rate of 30-40% of gross income include mortgage payments since this is in essence saving/contributing to an appreciating asset? If not, how could someone save 40% of their gross income if they have a 15 yr. $750K mortgage which you’ve previously indicated is the ideal mortgage unless they make roughly $1M/yr?

  9. Sam, i really enjoy reading all of your articles. In one of your articles you mentioned that someone could retire comfortably if they had assets that equal 50x annual expenses. Are these only investable assets or could they also includes equity in their personal residence. I am 53 and my investable assets are about 40x annual expenses and my home equity is about 10x annual expenses. Thanks for all the great info.

  10. I relate to this article so much. I actually quit my job recently in my late 20s after the NW hit 20X annual income because I just couldn’t care less about it anymore. Sometimes I wish I kept the job just to have more income to buy more assets, but I also know I’d be hating life a lot more. Grass is always greener syndrome.

      1. I’m working on a website that will hopefully serve as regular income down the line (altho as I’m sure you know it takes a while before you see much traction). Also watching for new investment opps. Still getting used to not receiving a regular paycheck – it certainly is one of the more addicting things in this world.

  11. “Once your net worth is over 20X your annual income or 50X your annual expenses, tremendous apathy begins to take over.” I’m close with my investments= 18x annual income, 45x annual expenses. I wouldn’t say tremendous apathy, but I do know that if I told most at work how much money I had they would absolutely say, ‘what the hell are you doing here dealing with this crap.” Part of my answer is mental stimulation. I like the challenge of the work and I haven’t quite found anything compelling to replace it, at least not yet. Only thing right now that would compel me to retire is the freedom to travel more, but you know Covid, not impossible but more inconvenient. But im also realisitc, there is only so much travel I can do before I’d be back home and then “what next?”. I don’t have the what next figured out so I keep working.

  12. Really love this post and very timely as I was just bringing this subject up with my wife during one of our nightly walks. Including this year we will have made more in investment returns over the last 4 of 5 years. The last 3 being the biggest.

    Current NW is about 30X expenses. Time to think about changing gears… :)

  13. I agree with the 20X income and 40X expense rule. It just feels right and let’s me sleep at night if I retired. We’re around that level right now but are still allocating 85% in risk assets. In the bad scenario, we can live off of half of what we have. Hoping for sufficient upside in the next 5-10 years that we can buy a house as nice as yours, Sam, and vacation first class all the time.

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