Posted by: Nico | 2013/07/25 18:20
I have been saving R1500 per month for 10 years with a 10% increase per year. They gave me a high and low growth estimate of R333 500 and R410 500 respectively. For this example I am assuming an inflation rate of 10%.
Effectively I am saving R1500 per month every year as the 10% increase cancels out inflation. i.e. in the second year I am saving R1650 per month but this is worth R1500. So in essence I am saving a total of R180 000 (R1500 x 12months x 10years = R180 000).
Only looking at the low estimate one would think that saving R180 000 and getting R333 500 is not a bad deal but the R333 500 I am getting is not worth R333 500. It is really worth R128 579 (R333 500 ÷ 1.1^10).
This means that I paid R180 000 for R128 579!
Am I looking at this the wrong way or what is going on?
I do realize people argue about what inflation is and how much it is. Using different values for inflation for the calculations above does not make this a “good” investment, one only approach a breakeven point. I do not want to break even with my money that I am investing, I want to make money!
Posted by: Simon Brown | 2013/07/26 08:09
Nicol, I am going to come at this from a different direction using the rule of 72.
Rule f 72 says you divide your expected growth into 72 to get the number of years for the investment to double at that growth rate. So expected growth = 10% the number of years for the principle amount to double is 7.2 years. But that excludes inflation.
To bring in inflation we need to have the net growth for the spending power to double. Take expected growth say 10% subtract inflation of say 6% leaving 4%. Divide that into 72 and you get 18 years for your spending power of the investment to double, real wealth creation.
Expected net growth (growth less inflation) is around 7%, so money doubles its spending power about every 7 years.
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