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Jonathan's AnswerView 11 Other Answers
Jonathan SteinJonathan Stein, CFA, CEO of Betterment.com
Congratulations on your successful exit! You have achieved the dreams of so many people - career success and financial independence. I hope you are savoring it, pleased with your accomplishments, and excited about what's next.

It sounds like you now want to "bank" your hard work and have it provide you and your family with a secure and happy future - this is a common goal of folks in your situation. If you live modestly and invest wisely, you will be in good shape.

I recommend an index-based ETF investment strategy. Such an approach might be expected to provide you with ~$100k/yr after tax, adjusted for inflation. This should be enough to live comfortably, preserve your principal, and free you to use your time pursuing what you like.

The technical details:
  • With $5mm, invested aggressively (say 90% stocks, 10% bonds), you might expect to earn between 5% to 10% over the long term (30+ years). Call it 7.5% annually - a reasonably conservative estimate, by most accounts. In some years you'll do better, and in other years you'll do worse.
  • A basic analysis, assuming average returns, would suggest that you could take out as much as $375k/yr (= 7.5% x $5mm) pre-tax or roughly $240k/yr ( = $375k * (1-35% tax)) after tax.
  • However, I would recommend you also account for at least 3% inflation - you want your income to grow each year, right? So, leave in 3%, and a little extra for some downside cushion (4.5% total), and you still should be able to withdraw 3% per year.
  • Withdrawing 3% per year gives you $150k/yr (= 3% x $5mm) pre-tax or roughly $100k/yr (=$150k x (1-35% tax)) after tax, today.
  • This withdrawal amount should grow over time (3% each year of a fluctuating - but on average, growing - principal basis). In 30 years, compounding at 4.5% (7.5% average gain - 3% that you withdraw for living costs), your $5mm might be expected to grow to ~$19mm (= $5mm x (1+4.5%)^30) and be providing ~$365k/yr of after-tax income. (This should more than compensate you for 3% annual inflation; $100k/yr today is equivalent to $240k/yr in 30 years with inflation of 3%.)
  • This analysis assumes current income tax rates. Much of what you withdraw, if invested in passive index funds as those used in a Betterment account, would be taxed at long-term gains rates - or 15%, currently. I did not account for this here because I expect long-term capital gains rates to increase in the future. (They are currently at a historic low point.)

Remember, you should not increase your withdrawals above 3% of the base in years when the market is up big, nor should you need to decrease your withdrawals below 3% of the base in years when the market is down. Consistency and patience are key.

For a liquid asset, this is perhaps the best you can do. The strategy is not unlike that pursued by many large endownments - many of which use perhaps 3% of their "corpus" or capital base for operations every year.

A direct investment in real estate (as recommended by Leo Polovets) has a couple of downsides:
  1. It's less liquid than stocks and bonds. So, if you decide to do another startup, or leave for Bali, or whatever, you may not have access to your cash when you want it.
  2. It tends to have lower returns than stocks over the long term - unless you're doing all the management yourself (which presents you with a large opportunity cost).
My company, Betterment.com, offers the best way to implement the index ETF strategy I outlined, help you live better off your earnings, automate the routine management tasks, and provide guard-rails and advice to keep you on track. I personally would be willing to advise you, and assess your overall situation, if you'd like. Alternatively, you could pursue such a strategy on your own, and I'd be happy to point you in the direction of how you could do that, too. Congrats again.