Joseph Galson has reached his 70th birthday and is set to retire. He has saved his money and owns his home with zero mortgage. He does not want to move. He plans to eventually bequeath the house and any remaining assets to his daughter.
He has accumulated an investment portfolio of $180,000, which is currently yielding 9% interest — $16,200 per year or $1,350 per month. He plans to draw down on this portfolio to pay for retirement expenses.
He also has $12,000 in a savings account, which is currently paying 5% interest. He wants to keep the principal of the savings account unchanged.
Mr Galston is entitled to receive $750 per month in Social Security for the rest of his life. These payments automatically increase in proportion to changes in the Consumer Price Index.
Mr Galston’s basic living expenses currently average $1,500 per month. When he retires, he plans to spend an additional $500 per month on travel and other pleasures.
Mr. Galson is concerned about inflation. The annual inflation rate has been below 3%, but he is concerned that inflation could rise after he retires.
Please advice Mr Galston in following:
Can he safely spend all the interest from his investment portfolio of $180,000? How much can he withdraw every year-end from that portfolio and still keep its real value intact?
Now, suppose Mr Galston can expect to live 20 years and is willing to draw down his investment portfolio to zero by the time he dies. He also wants his monthly spending to increase along with inflation. In other words, he wants his monthly spending in real (inflation-adjusted) terms to stay constant. Assume that the investment portfolio continues to yield 9% and the savings account 5%, and that inflation will be 4%. (Note that he wants to keep the principal of the savings account unchanged.)