Archive for the ‘What your Financial Planner Won’t Tell You’ Category

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So what is it worth NOW?

Thursday, September 25th, 2008

Yesterday we looked at using the Rule of 72 to project Present Values to Future Values.

 

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.

           

R10 000

/

2

=

R5 000

R5 000

/

2

=

R2 500

R2 500

/

2

=

R1 250

 

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:

Illustrated Maturity Value:

R3500 000

 

 

 

 

Years to Maturity

20

 

 

 

 

Inflation

10

 

 

 

 

Rule of 72 Factor

72

/

10

=

7.2

Doubling

20 years

/

7.2

=

2.8

1.

R3500 000

/

2

=

R1 750 000

2.

R1 750 000

/

2

=

R875 000

3.

R875 000

X

0.8

=

R700 000

What Monthly Income can you get?

R700 000

/

20

/

12

=

R2 916 / month
               

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! 

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Posted in Do your own Calculations, Financial Planning, What your Financial Planner Won't Tell You | No Comments »

How Much is it When I Retire?

Wednesday, September 24th, 2008

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.

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Posted in Do your own Calculations, Financial Planning, What your Financial Planner Won't Tell You | 2 Comments »

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