Enter The Year Of The Dragon

by Andrew Wood The Chinese year of the dragon is thought to be an auspicious year and one in which there will be a number of things which will have greater eect than usual, whether they be good or bad. In other words if your luck is good it will be enhanced and if it is bad it will be horrid. However you look at it the world will still spin and there will still be European debt and Middle East unrest. The US presidential election will run in November and the population will surely grow beyond 7 billion. Some say that 2012 is the year the world will end in dramatic catastrophe, with numerous volcanic eruptions, earthquakes, tsunamis and other unknown phenomenon. Others say enough of the superstition; lets get on with reality. Thanks for the feedback to Net Worth articles published so far in 2012. There were a number of interesting points on re ections and projections and even more on last weeks meaningful nancial life plans. These two were related in many ways. They came from dierent ends of the spectrum but merged rmly in the centre. The fact is you need to start with a meaningful life plan from which you can assimilate the projections and ne tune things to suit the current situation as time marches forward. One of the most controversial aspects is the concept and the far reaching eects that in ation has on us all. For those who disregard in ation there will either be a hard landing in the future or they have sucient nancial backing to remain almost visibly unaected in terms of their overall net worth. For the vast majority of us it is not just the fact that in ation exists but more how it really has a cumulative eect on us all as time goes by. This is viewed by many as something they do believe but cannot see how it will damage them until it actually happens and its too late. Lets say that your cost of living today totals $50,000 per year and in ation is 4%. The total cost of living in 20 years time will be $111,129 per annum. Yes, I hear you say, that is most interesting and something we will need to cope with when we get there. If you try to imagine what $50,000 means to you today and then also what $111,129 means to you in reality today you will understand this intrinsic dierence. However, if you need $50,000pa to live today that would total $250,000 over ve years. If it were $111,129 today that would be $555,645 over ve years. So, how long would it take to accumulate $250,000? Quite some time. Now, how long would it take to accumulate $555,645? Wow that is a huge ask is it not? Now just realise that is only living costs for a ve year period and things will continue increasing in cost beyond that meaning you will need even more accumulated capital. Perhaps there are some readers who now see the signi cance. The point here is to realise that in ation has a massive eect on everyone and the sooner you begin to accumulate reserves toward nancial independence the better. In a similar light compounding growth on accumulated capital savings has a positive eect in the opposite direction making your assets grow even faster than you had envisaged. To demonstrate this a little more succinctly lets say you have $50,000 which you invested and achieved a return of 7% per annum. In this example you could draw the accumulated interest and would enjoy $3,500pa to spend. Assuming no changes you would receive the same gure each year so over a ten year period you would have spent $35,000 and still have your original $50,000 capital. However, if you did not draw any income but instead let the growth compound you would have $100,483 which is quite a lot more than $85,000.

So, by combining the growth you receive and applying the in ation rate you may need to bear we can calculate how long your asset pool will last. Using the gures in our illustration so far lets assume that you are 40 years old and decide to save $1,500 per month toward retirement at a planned age of 60. You will increase this each year in line with rising salaries at say 10%. The results of these savings over a 20 year period, at a growth rate of 7%pa, will be:

Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Annual Savings $18,000 $19,800 $21,780 $23,958 $26,354 $28,989 $31,888 $35,077 $38,585 $42,443 $46,687 $51,356 $56,492 $62,141 $68,355 $75,190 $82,710 $90,980 $100,079 $110,086

Accumulated Investment Value $19,260 $41,794 $68,024 $98,421 $133,509 $173,873 $220,165 $273,108 $333,512 $402,271 $480,386 $568,964 $669,238 $782,575 $910,495 $1,054,684 $1,217,011 $1,399,550 $1,604,603 $1,834,718

So when you reach age 60 you have a total investment pension pot of $1,834,718 and so congratulations are due as this is looks like a really signi cant gure. Do you feel that this will last a lifetime of paying pensions to you and also maybe even have a residual balance as a legacy for your intended heirs? If you do it will be worth your looking at the next table which demonstrates how in ation crushes the plan. Taking an initial value of $1,834,718 and making this continually grow at 7%pa we now start to draw a pension, based on todays gure of $50,000 but in ated at 4%pa to the retirement date in twenty years time. If you recall this requirement is then $111,129 in the rst year. In ation does not retire when you do so we must assume that the 4%pa in ation continues thereafter. Our next table shows how this works:

Age 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84

Opening Balance $1,834,718 $1,852,019 $1,866,086 $1,876,515 $1,882,866 $1,884,661 $1,881,382 $1,872,465 $1,857,300 $1,835,223 $1,805,517 $1,767,405 $1,720,046 $1,662,528 $1,593,867 $1,512,998 $1,418,771 $1,309,942 $1,185,170 $1,043,005 $881,883 $679,358 $457,684 $215,581 -$48,304

Add growth at 7%pa $128,430 $129,641 $130,626 $131,356 $131,801 $131,926 $131,697 $131,073 $130,011 $128,466 $126,386 $123,718 $120,403 $116,377 $111,571 $105,910 $99,314 $91,696 $82,962 $73,010 $61,732 $47,555 $32,038 $15,091 -$3,381

Less Pension Withdraw Inflated 4%pa $111,129 $115,574 $120,197 $125,005 $130,005 $135,205 $140,614 $146,238 $152,088 $158,171 $164,498 $171,078 $177,921 $185,038 $192,439 $200,137 $208,143 $216,468 $225,127 $234,132 $243,497 $253,237 $263,367 $273,901 $284,857

Residual Fund Value $1,852,019 $1,866,086 $1,876,515 $1,882,866 $1,884,661 $1,881,382 $1,872,465 $1,857,300 $1,835,223 $1,805,517 $1,767,405 $1,720,046 $1,662,528 $1,593,867 $1,512,998 $1,418,771 $1,309,942 $1,185,170 $1,043,005 $881,883 $679,358 $457,684 $215,581 -$48,304 -$335,406

You can see that you have actually exhausted your investment pot completely by age 83. So those 20 years of savings have been wiped out completely by an in ating requirement for living expenses as you go into retirement. That includes growth at 7% and in ation at much lower level of 4%pa. Some shall say I shall never retire whilst others will retort I shall die before I reach age 83. To those people I say take your head out of the sand and face reality. In ation may not run at 4% consistently. This tends to be relatively real although expats generally tend to suer from higher rates than this. Investment returns of 7% are not easy to generate although it is possible. So, these examples are based far more on optimistic reality than pie in the sky guesstimates. Find a solid professional nancial adviser today to help you plan and overcome these constant hurdles in life.

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Questions to the author can be directed to PFS International on 02 653 1971 or emailed to enquiriesthailand@fsplatinum.com