The Blue Roof

Yesterday I showed you an easy way to calculate the capital you need to be able to retire.  Today I will show you another easy way to calculate the future value of the capital you require.

 

Let me say this at the beginning:  this is not 100% accurate, but it is close enough.

 

Today we will focus on the first part of the Rule of 72.  The Rule of 72 says that any amount of money will double in value by the result of 72 divided by the rate.

 

Let’s simplify.  Let’s say that you invest money at 9% per annum.  Then the Rule says:  72 divided by 9 = 8.  Therefore your money will double in value every 8 years.  So, if you invest R10 000 at 9% pa, it will grow like this:

 

After	8	years	=	R20 000
	16	years	=	R40 000
	24	years	=	R80 000

 

Now you can do the same with the figure we used yesterday.  If your income increases by inflation every year and inflation equals 6%, and we stick with the R10 000 we used yesterday, it looks like this:

 

After	12	years	=	R20 000
	24	Years	=	R40 000
	36	Years	=	R80 000

 

Unfortunately life is not always as simple as this.  So what do you do if the rate is 10% which means it doubles every 7.2 years?  It’s only slightly more complicated, so bear with me.  So let’s say we want to know the value in 20 years’ time (Incidentally, even if the rate was 12%, you would still do this). 

 

Step 1:	20 / 7.2	=	2.8
Step 2:	R10 000 X 2	=	R20 000
Step 3:	R20 000 X 2	=	R40 000
Step 4:	R40 000 X 1.8*	=	R72 000

• *Step 1 & 2 refers to the 2 in the factor of 2.8.  If the factor was 3.8, you would double a third time.  The 1.8 in step 4 is 1 + 0.8, so that you increase the answer in step 3 by 0.8.  Just remember that when you work from present to future you have to multiply the last step by 1 + the fraction.

 

So, how are you going to use this newly acquired skill?

Step 1:	Use the assumed inflation rate and the Rule of 72 to see every how many years your salary
Step 2:	How many years do you have to retirement?
Step 3:	Divide your years to retirement by the answer in #2
Step 4:	Now calculate your salary in the year you retire.

 

Example:

 

Step 1:	Assume and inflation rate of 9%.
Step 2:	20 years to retirement
Step 3:	Salary will double every 8 years
Step 4:	20/8	=	2.5
Step 5:	R10 000 X 2	=	R20 000
Step 6:	R20 000 X 2	=	R40 000
Step 7:	R40 000 X 1.5	=	R60 000

 

 

 

Therefore my salary in the last year will be R60 000 per month.

 

Example 2:

Yesterday we calculated that if we retired TODAY with R10 000 per month increasing at inflation and investment return equals inflation the capital we will need is R2 400 000.

 

Now see how much that will be 20 years hence:

           

R2 400 000 X  2	=	R4 800 000
R4 800 000 X 2	=	R9 600 000
R9 600 000 X 1.5	=	R14 400 000

 

R14 400 000 is the capital I will need 20 years hence.

 

I LOVE FIGURES.  Check your calculations!

R60 000            X            12            X            20            =            R?????

 

Now do the calculation for yourself.  I would LOVE to hear your comments.  So please let me know.

 

Tomorrow we look at the other part of the Rule of  72.  And the next day, which is Friday, I will give you the scary news.

 

But please, do the calculations for yourself and even bigger PLEASE, talk to me.

Financial Planning is very simple, but the calculations are not.  That is why so many people live in a fool’s paradise regarding retirement!  They don’t understand the calculations; don’t know how to interpret the figures and accept that a “specialist has done it, so it must be fine.”  The end result is mostly devastating.

 

So I am going to show you two easy ways to do the calculations.  Obviously it is not 100% accurate, but it does give you a ballpark figure against which you can compare.  And it is really easy, everybody can do it.

 

So how do I know how much money I will need to be able to retire?

 

Let’s get answers to the following questions:

 

1. What is your current income per month?  You would probably like more, but let’s say you would like to retire TODAY with the same income.
2. How long are you going to live after retirement?  Now that is a difficult one, is it not?  As long as possible?  As long as my money lasts?  As long as the Mortality Table show?  But we live longer – our life expectancy is increasing.  Just for now, say 20 years.

 

Now we make an assumption that some people may say is conservative, but which I think is very optimistic.  We are going to assume that the inflation rate and the investment return rate is the same.  In other words inflation rate = investment return, 

 

Now we are ready to calculate how much capital we need.

Multiply your required monthly income by 12 (to annualise) and then by the number of years you expect to live.

 

Example:

Income required = R10 000 per month

R10 000 X 12 = R120 000 per year

R120 000 X 20 (life expectancy) = R2 400 000. 

 

Interpretation:  subject to our assumption, if you want to retire TODAY with a monthly income of R10 000 per year increasing annually by the inflation rate, you need R2 400 000. 

 

Tomorrow I will show you a way to estimate what the end figure will be.

 

For now, just calculate this figure and play around with different incomes and life expectancy figures.