I am actually surprised that nobody came back and claimed that in real life investment return is higher than inflation. I don’t agree with that assumption either. When I was still working as a financial planner, one of the investment companies gave us regular feedback on the return on various portfolios over different time frames. And the inflation rate for that time period. You know what? Not any one portfolio could beat inflation consistently. It might do better than inflation for a year, or two or three, but ten years and longer? Sorry, inflation is better. It all makes sense, of course.
But the bottom line is: the assumption that the investment out performs inflation is not correct.
You see, they say the INDEX of the stock market outperforms inflation, and I will agree with that. But there is no money to be made by selling the index, so you are strongly discouraged to buy the index by references to the funds that actually did outperform the index in that year! The real life situation is that the index does better than 75% of the portfolios. In other words, only 4 in every 100 portfolio’s do better than the index. Unfortunately it is NOT the same portfolio’s every year. So, how do you know on 1 January which portfolio will do better than the index by 31 December? You don’t.
And keep in mind, am talking portfolio. The portfolio consists of YOUR money AFTER costs. So if the portfolio grows by 10%, it is your net investment that grows by 10%, not the money leaving your pocket.
That means that we should actually have increased the amount of money that we need to save to allow for costs!
But enough of that, you understand that I don’t accept the assumption that investments outperform inflation.
But I can be wrong. So, let’s say we stick to the generally accepted rule of saving 15% of income for retirement.
I am going to do two calculations:
1. I want the equivalent of R10 000 per month for 20 years 40 years from now. And 40 years from now inflation = investment return. But for the next 40 years inflation will be 6%. What investment return do I need? The answer is: 12%, or double the inflation rate. The 12% is not inconceivable, but double the inflation rate? That just does not correspond to reality. Once again, I am not talking about spikes where you get a 20% return in 1 year. I am talking returns over 40 years.
2. I want the equivalent of R10 000 per month for 20 years after 40 years and I assume the investment return is 3% above inflation. How much should I invest?
The answer looks like this: In 40 years time I need R19 182 670. To get that at 9% per annum (3% above inflation) I need to consistently save 22,7% of my gross income for 40 years.
I still don’t think that is achievable. What do you think?