If you retire today, with the assumption that inflation = investment return, and that your income will increase by the inflation rate for 20 years, that is 240 months, what happens in month 241?

You will have no money left.  Let me repeat that:  you will have no money left.

Assumptions:

Required initial income is R10 000 per month for 20 years.  Income and capital grows by 6% per annum (inflation = investment growth rate).  That means that I need R10 000 X 12 X 20 = R2 400 000 in capital

Look at the table below.  After 20 years (in the Table Year 19) I run out of capital!  So what are you going to do in month 241?

Understand the Table.  At the beginning of year 1 I take out R120 000 for my first 12 months income.  I invest the balance.  Beginning of year 2, I take out what I need and invest the balance.  And I carry on like that.  In year 19, I only have available exactly what I need for the year.  Do I hear somebody say:  “I will earn interest on the money for the year.”  I hope you do, but the effect is negligible.

How many people do you know or know of, who, a couple of years ago took a severance package, or who retired and are now working again, because they obviously have to?  In all probability, this is the reason.

Or as the Financial Mail article said:  “The luckier retirees live off alternatives such as rental income, or their children. Others don’t even have those resources.” Read it here.  So there is the answer and the solution!  You have a choice:  invest in property or have children!

Today we will do the opposite. 

Today the Rule of 72 says that any future amount will HALF in value in the number of years of the result of 72 divided by the rate.

So, that means that if the inflation rate is 8%, then the purchasing power of your money will HALF every 9 years.

So look at R10 000.

What does it mean?  It means that every 9 years you will be able to buy with R10 000 what you can currently buy with R5 000/R2 500/R1 250!

Or put differently.  In 1980 my dad bought me a BRAND-new Nissan 140Y SDX with a full tank of petrol for R5 500.  Not so long ago my brother-in-law paid R15 000 for a not so fancy mountain bike!  That is what is meant with buying power of your money.  We experience it everyday.  I can buy less this month with R1 000 than last month.

But, let’s take it one step further.  You might have an endowment policy or a Retirement Annuity.  What does the company give you as an illustrated maturity value?  Will you be able to survive financially?  You can now work out what it will buy you.

Example:

Let’s interpret the example:

I am saving very diligently and the Investment Manager Company says I can expect to get R3 500 000 in 20 years time.  To all of us that is a lot of money, because we are think with a present value framework.  But is it enough?

So now I use the RULE of 72 and find that every 7.2 years the purchasing power of my money will half.  So that when I do get this money 20 years from now, I will be able to buy the same value that I can now buy with R700 000.  That’s not a lot.

And when I calculate the monthly inflation linked income I can get for 20 years, I suddenly discover a very, very dismal future. 

That is why in February 2008 the Financial Mail said:   

The average SA pension fund member is facing a life of poverty at retirement. Despite putting aside up to 15% of their salaries during their whole working careers, retirees on average face living off 30% of final income at retirement.   Read it here.

Do you understand why you financial planner does not want you to know this?  And I repeat:  it is not 100% accurate.  But I use these calculations as a very quick and easy way to separate the chaff.

Tomorrow I will give you the last bit of bad news.  Don’t worry, you already have the solution under The Blue Roof!