Retirement

So one day you are planning to retire?

This is NOT advice to be used by South Africans as I am a South Africa and I am NOT a qualified financial services provider. In other words, I speak the truth.

If you invest money into an investment that offers a 10% annual return year in and year out, look as what happens in a typical scenario:

1. You invest R1000 in a bank today. That R1000 buys you R1000 of food today. It pays R1000 worth of debt today.

2. If inflations runs at 5% by this time next year your R1050 will buy you what R1000 buys you today.

3. And at end year 2 you will need R1102.50.

End year 3, you will need R1157.63

Year 4, R1215.51

Year 5, R1276.28

Year 6, R1304.10

Year 7, R1407.10

Year 8, R1477.45

Year 9, R1551.32

and after 10 years, you will need R1628.90 to buy what R1000 buys today, assuming inflation remains constant at 5%...

And this assumes NO taxation, NO fees or costs associated with your investment. Let's assume you have a 10% (!) interest rate from your bank (hey, this is only hypothetical dream land after all...)

Take a look at what happens to your cash. After year 10, your cash has increased to R2593.74 - or has it?

Well, no not really. The whole calculation is completely wrong.

IF you can find an investment when inflation is running at 10% that pays 10% good for you! But that's a tall order and the sad fact is that the majority will NEVER find that kind of return.

So let's track the harsh reality stripped of all the bank nonsense and rhetoric and advertising crap.

After year 1 let's see where you stand

R1000 at 10% is R100 interest. So you now have R1100 in you account. The bank will take, say R200 to run your account for the year and for sending you statements.

So you're completely screwed after just one year. Your investment implodes.

But no one invests 'only' R1000. Let's assume R10 000 is your lump sum.

Now, the R200 that the bank takes from you seems more palatable.

After year 1, you have earned R1000 interest, less the R200 for the privilege of leaving it with the banking institution of your choice. That leaves you with R800.

Now, if this is your ONLY interest income, the Receiver of Revenue will graciously allow you to keep the interest without paying any tax on it (despite the fact that you paid the tax on the original R10 000!).

Let's see where we end up

End year 1 - R11 000 less R200 = R10 800.00

End year 2 - R11680.00

...

End Year 10 you will have R20 863.58 assuming bank fees don't go up, and you get 10% every year. Inflation has ensured that R10 000 will have the same buying power as R16 289.00 (as per the inflation example above) goes. So you are up R4 574.80 over the 10 year period, a tidy 45.748% on your initial investment.

Which over 10 years represents not 10% compound growth, but a whopping: Wait for it: 8.52%...

Now if you can live on less than R1000 a month, well good for you. I know I can't, and that's R1000 in today's terms.

I know that I need R10 000 to live to the lifestyle in which I have become accustomed, and this assuming I have NO DEBT at all...

Now let's take a look at what really happens... at about the same time you realise it's too late and you're screwed.

R10 000 a month with inflation running at a mediocre 5% means in 10 years time I will need R16 289.00 to buy the same stuff that R10 000 buys today.

So, if I invest at 10%, I will need R1 100 000 in the bank. This will give me income of R110 000 which is close enough to my R120k I will need. I take off the generous R11k that I am allowed to by the Receiver and pay tax on the balance of R99 000, which if I am over the age of 65, and this interest is the sole source of my income, I will have to pay an additional R20 000 in taxes reducing my net income to R79 000 for the year or about R6583 a month with no appreciation which after inflation amounts to about half of what you are used to....