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Tuesday, 14 June 2016

Investment Rules of Thumb

Opposable thumbs - not just for
Facebook likes. 
In a recent article I detailed the investment returns and inflation rates I expect going forward (I also made a handy lookup page for these values). And now that I have that information I can run some calculations and generate some "rules of thumb" to use as a quick estimation to calculate investment figures.

I found this exercise interesting, and it clearly illustrates the power that time can have on your investment. But I also found it to be a great motivating factor to invest more, because the power of compound interest gives some very impressive numbers!

I am using a predicted equity investment return of 15.28% and a predicted inflation rate of 6.28% (which I got from this page). This works out to a real return of 9% per year, which equates to a 0.7207% real return per month (compounded monthly). Using this I have calculated what various monthly investment amounts will get you over 5, 10 and 15 years.

Monthly Investment Value After 5 Years Value After 10 Years Value After 15 Years
R100 R7 527.15 R19 108.60  R36 928.10
R500 R37 635.75 R95 543.01  R184 640.51 
R1000 R75 271.49  R191 086.02  R369 281.02 

So just R100/month for 15 years gets you almost R37k in today's money. Using the 4% rule that gives R123 per month for the rest of your life! So sacrificing some expenditure today and investing it for 15 years will generate you an income in excess of the sacrifice - and you will not be able to get rid of this income for the rest of your life. What a terrible problem to have...

Using the above table I have taken this a step further and calculated some rules of thumb as a rough guide to estimating what a certain monthly investment (Rx) will be worth after a certain amount of time (and I have added these to my Stealthy Wealth Numbers page for a handy quick reference)

To determine the value of your investment after 5 years, multiply your monthly amount by 75
To determine the value of your investment after 10 years, multiply your monthly amount by 190
To determine the value of your investment after 15 years, multiply your monthly amount by 360

I have factored in a "margin of safety" by rounding down to nicer numbers - So you will see that using the rule of thumb gets you slightly less than the table above - for example a monthly amount of R100 gets you:

R7 500 after 5 years
R19 000 after 10 years
R36 000 after 15 years

I like the 15 year rule because:
  1. I am currently around 15 years away from my early retirement
  2. 360 is an awesome round number!
Using the 15 year rule of thumb I have run some examples of expenses which I choose to eliminate (but which some anti-Stealth people insist on having) to illustrate how powerful this is:

Instead Of I Get
DSTV (uh oh **hides under table from the tomatoes being thrown by sports enthusiasts**) @ ~R700/month R252 000 towards my early retirement
A fancy cellphone (maybe something fruity?) @ an extra R400/month R144 000 towards my early retirement
A car payment (we plan on driving our paid off car for a good many many years before replacing it) @ R3000/month R1.08 Million towards my early retirement

Awesome stuff!

The Point of All Return

There is another awesome number I want to discuss. I call it the Point of All Return, and it beats the pants off the point of no return! The Point of All Return is the amount of time it takes for an investment of Rx/month to give you a monthly income of Rx/month for the rest of your life. In other words, how long do you need to invest R100/month to reach a point where the investment is large enough that you can stop contributing and instead draw R100/month for the rest of your life.

A drawdown of Rx/month equates to annual drawdown of 12x. From the the 4% rule, we know that to draw down R12x each year, forever, we need a capital amount of 25*12x = R300x. So the question then becomes, how long until you have 300 times your monthly investment amount? I have done the Maths for you and calculated that this point happens after 160 months, or 13 years and 4 months.

Now 13 years seems like an eternity, but consider this. If you work out that you could live on R20 000 a month, and you manage to invest R20 000 a month while you working, it means that after 13 years and 4 months you can stop working and retire. Put another way, if you are able to save 50% of your take home pay, you can retire in around 13 years time. For someone who has started working, at say age 21, this means they could retire at age 34! Now suddenly 13 years doesn't seem too bad! (If there are any 21 year olds reading this, I am very jealous and wish and I figured this out sooner!) They should be teaching this stuff at school.

I am adding the Point of All Return value to my numbers page as well.

Till next time, Stay Stealthy!

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