Retirement: How much is my
effort worth so far?
Money! What a huge subject. We each have so many
ideas about it, yet so few of us get it
right.
The most crucial
issue to grasp is that YOU have to take control of your
own future. If you allow any other person to look after
your money, you will depend on them for the rest of your
life. And if they screw your money up you will not have
any recourse.
You may think me a bit bold, but when I see how many of us live
out our lives without enough money to enjoy those last years, I
cannot help but think it is the truth.
Each of us has handed over that control at some time or other.
We do that because we think that the subject of money is too
complex for us mere mortals to grasp. That's rubbish.
Money is simple. It is even simpler when you
can use a PC to crunch the big numbers.
This report has one goal: to help you get to grips with your
money, right now, right here.
Lets start with a single core idea: If you can not make sense
of a scheme that you are being invited to invest in then do not
do it. Warren Buffett sticks to this rule, and even though he
is a genius, he admits that he sees a lot of stuff he does not
grasp, and so he avoids it. If that's good enough for the
second richest man on earth, it is good enough for me.
We are going to work with flows of money, and there
are a few concepts you must wrap your head around before we can
progress.
The first concept is INTEREST. If you borrow
money, this is the money you pay for the use of someone else's
money. If you save money, this is what you are paid for letting
others use your money.
The theory says that if you save enough, and add to that the
interest that you earn over a long enough stretch, then you
will retire rich. Almost all savings plans detail how your
money grows each year. These tables are usually worked out at a
8% interest rate and a 10% interest rate.
The problem is that this is pure fiction. Right now none of us
knows quite what the rate will be next year, let alone fifty
years hence. This means that those tables are pure guesswork.
(They're not even based on past facts, but are rates that the
regime insists the sales people use to stop them from
stretching the numbers too much.)
Interest, then, is mostly a good thing if you are saving.
The second concept is INFLATION. Each year
prices rise for each item we buy. You are getting the same
amount as last year, but stuff costs more. That is a very
simple answer, and I am happy to debate the reasons it happens,
but not today.
That means that one Rand this year buys more than the same one
Rand next year. The Reserve Bank wants to keep this change in
value of one Rand to below 4%, and uses a whole lot of cryptic
methods to do this. For now, these add no value to our story,
and we cannot change the Reserve Bank targets, so I am not
going to go down that path either.
Once again, this number is fiction. None of us knows what this
rate will be next year, or fifty years away. None of us
expected to be in quite so much dwang this year, and in just
twelve months the inflation rate has gone from about 4% to
about 8%. In other words, we would prefer one Rand of stuff
this year to only cost about R1-04 next year, but next year it
will cost about R1-08.
The problem with this gentle increase in prices each year is
that it gets silly. Who on earth really thinks that a loaf of
bread costing R10 now, will cost R31.18 in thirty years time.
And that's at the Reserve Bank's target rate of 4%. At
the current 8% that same loaf will cost R93.18. (The
numbers look wild, don’t they? Trust them!)
The most crucial thing that you must grasp is that
interest grows the amount of money you are saving while at the
same time inflation makes it worth less. Your
task is to put your chair between the two tables, and take a
wild guess at what your money will be worth when you get to
65.
Inflation, then, is mostly a bad thing. Unless you sell any
product that involves saving, because you can create monster
tables of numbers that exist only to baffle normal folk, or so
it seems. You MUST get a grip on the link between inflation and
interest if you want to sort this mess out, and you want to
emerge at the end with enough money to live on.
The goal
Your job is to plot a course so that you stay ahead of the game
each year. Your goal is to get a higher interest rate on your
savings than the inflation rate is going to bite off them. The
bigger the gap, the richer you get, as long as you are earning
more interest than inflation is eating.
No matter how good you are at this, you are still at the mercy
of some BIG event like Mugabe. The Zimbabwe inflation rate is
about 10 million percent as I write this, and anyone with an
income based on the interest rate is in trouble. (We will look
at this later in more depth.)
I know that it seems that the road forward is not very certain,
but here is a vital truth: Your guess about the rates is as
good as that of any expert! (They do not want you to know
that!) They’re either being paid to make the best guess they
can (economists, for instance) or they are biased towards
numbers which make the product they’re selling look its
best.
In fact, your guess about inflation is better than most
experts, because the inflation rate is not the same for any of
us. (It depends on which items we each buy each year, and we
each buy a distinct mix of goods.)
So how much will I be worth when I retire?
I am glad you asked. Each time you look at a plan to make you
rich you will find a table showing you how big the pot will be
when you reach 65. That pot contains all of the payments you
have made, and all of the interest your money has earned.
The problem is that we do not yet know what stuff will cost
when we reach that age. We do know what stuff costs right now,
but it is very difficult to project that into the future. In my
simple mind that means that the best way to get a feeling for
how much that final pot is worth is to work out what it is
worth in today's Rands (or Pounds, Dollars, Francs, Lekes,
Taka, Leva, Won or Dong).
For now I am going to assume that you have a 'normal'
investment with some big bank or investment firm, and that they
can project the size of your pot for you. If your plan to
retire is based on the value of your vintage stamps, classic
cars, your firm, or nine homes in the Algarve, then only use
this section to see what your money savings will be worth.
What you must do is work out how much buying power that pot of
gold really has. To do this we work out the effects of
inflation between now and 65. Each year inflation eats into
your buying power. To work this out we need two numbers and a
guess.
The first number should be easy: The size of
the pot of gold (the maturity value of all your savings
projections) that will be paid to you when you get to 65. This
will be on one of those tables that your broker gives you. If
you don't yet have such a table, ask for one!
Then we need a date that you plan to retire (or the date which
these maturity values become yours).
And now you must take a guess at what you
think inflation will look like over the period until you
retire. Right now, this is a wild guess, but it makes sense to
work with the Reserve Bank target rate of about 4%.
For now we will ignore any interest rates because most
of us have very little control over the money we're saving in
plans like retirement annuities, pension funds, or provident
funds. Simply take the number they're telling you they will
reach.
Working it out is simple.
I find it rather
fun to just mess with the numbers and see what happens.
But then I really need to drink less coffee!
The value in today’s currency is a really important number, so
write it down because I'd like to show you how your monthly
income after 65 is usually worked out. This is crucial. This
one choice, often made without enough knowledge, could either
screw up your future, or make it a lot more fun. Either way,
you can’t go back and choose again if you chose the wrong
path.
(Although it is just one choice that you make, the variety of
options is truly baffling.) We will discuss these later. For
now, lets look at how your monthly income is calculated -
here.
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