IS YOUR MONTHLY CONTRIBUTION GOING TO WORK FOR YOU?


Investing & Money
piece written on the 20th February 2014 by  

I wrote a post on simple investment calculations with compound interest at the beginning of this month. The post has received a good amount of traffic and I’ve been asked a few questions about it by people who are interested in investing now and knowing that they’ll be alright when they retire. First off, it’s really great to see people thinking about their futures especially considering how only a tiny percent of South Africans are able to retire, but secondly, the questions are asked in such a way that I can tell that people aren’t completely understanding how much will it be worth later. I’m not an expert, but I want to try and put some reality down in place for people to at least get an understanding of money growth.

From chatting with friends, colleagues and financial advisors, there seems to be a trend about getting people to commit to between R300 and R1000 per month so I’m going to work inside that scale.

Simple Scenario:

The table below shows you what your monthly contribution would turn into if you invest X amount per month for 40 years at an annual interest rate of 10%. This does not take annual increases on your monthly contributions into place, nor does it include an initial investment. X amount per month over 40 years at 10% return.

compound interest table

One might look at this and think, if I invest just R500 a month I’ll be able to retire no problem. Unfortunately that’s not the case and that is the reason for me writing this article. There are a few things that we haven’t included, the first and most obvious is inflation. If I’m not mistaken, inflation currently sits at 5.8% (source). What this means is that the 10% interest you’re gaining each year relative to inflation is actually only 4.2% – more than half. So, let’s look at the table again talking inflation into account:

Compound Interest Inflation

Now those  numbers aren’t looking as great are they? Quite scary in fact. The bad news doesn’t end there unfortunately, we haven’t taken investor fees either. Investor fees can range considerably from 0.1% all the way up. If you’re not clued up, chances are you’ll pay more investor fees than you should, that’s just how it goes. Same as when you buy your first car and don’t know how to get a better interest rate. If we take investors fees at 0.5% per annum and take that away from the 4.2% (10% interest less 5.8% inflation) we land up at 3.7% interest per year. The numbers in the above table won’t change too much, but it’s still a decrease and a closer understanding to what your monthly contributions will turn into. Let’s do the table once more:

Compound Inflation Advisor

Rather depressing really – R1,000 a month for 40 years and you’ve effectively got R1,084,028. I must just mention, that’s taking inflation into account so this is the amount you’ve relatively made and it’s important to remember that.

So the purpose of this post is to put some real numbers down; far too often we have people telling us how just a little can grow to a lot and although that’s true, we always need to think of inflation, broker fees and the likes. What I haven’t mentioned though is that when you cash our your policies and such you still have to pay tax on them so the ultimate amount is even less.

Let this blog post inspire you to rethink what you’re saving each month and remember that when you retire around 60/65 you’ll need to live off the amount. If we’ve invested R1000 per month for 40 years we’ll have a million. If we live for another 20 years, that’s 240 months which divided into a million leaves us with R4,166 per month to live off.

HINT: The secret to combating the inflation is to increase your month deposits by the rate of inflation each year or more! Doing this will leave you with a far more valuable investment when you retire!

Note: All calculations based using one of my financial calculators.

The math:

  • Capital Accumulation Formula: FV = ( (1 + i)n ) * PV
  • Future Value of a Series Formula: FV = PMT * ( ( (1 + i)n - 1) / i )

Where:

  • FV = Future Value
  • PV = Present Value
  • PMT = Periodic Payment Amount
  • i = interest rate per period
  • n = number of periods