I fancy working on an easy Blog after a few recent ones on Stocks where I have had to use my Brain - I am in full Summer Mode now and there are plenty of more interesting things going on than the Stockmarket and all its accoutrements.
A while back someone asked me to do a Blog on how much Money you might need to give up Work. I have been thinking about how to write this one and got distracted quite a bit, but I reckon I have the shape in my mind now. However, in order to write that Blog, I need to write this one first - i.e, I am still ducking the Request !!
http://wheeliedealer.weebly.com/blog/the-rule-of-72-and-its-implications-on-our-expectations
OK, let’s get started.
The Maths
I will take an Example Amount of Cash and multiply it by a Percentage Annual Return. I will then take the Result of this Calculation and multiply that by the same Percentage Annual Return, and then I will take that Result and multiply it again by the same Percentage Annual Return, etc. etc.
By doing this sequence, it should show how the Starting amount of Cash grows over time according to the CAGR - Compound Annual % Growth Rate.
The Parameters of the Calculations
I will start with a Sum of £10,000 - this is pretty much an arbitrary figure but it should be an amount that people can relate to. I understand these numbers are Commutative - so if you have £100,000 as your Starting Point, then you just add a ‘0’ onto the numbers (i.e. multiply by 10). If your Starting Point is £40,000, then just multiply by 4. If your Starting Point is £5000, then halve the numbers - you get the point.
The Annual Growth Percentages I will use are as follows:
- 3% - this would be a very good Return on Cash at the moment.
- 5% - nice round number.
- 7% - Real Returns (after Inflation) for the Stockmarket over many years are around this kind of number. In theory, you could get this from Index Tracker Funds - however, with Costs and suchlike I doubt this would be easy.
- 10% - This is the kind of Return I aim for on the Exposure Value of my Portfolio. I am sure many Great Investors and Traders achieve more than this - but it takes effort and I am happy to have an easy life and not trade all that often.
- 12% - A bit of Safe Leverage on a Portfolio should make possible this kind of Return - but it is far from easy.
- 15% - this is an extremely good Return - few people can achieve this.
- 20% - an Exceptional Rate of Return - Buffett probably only just gets near. Robbie Burns does better than this but he is extremely unusual.
Please note, I am totally ignoring Inflation for ease and simplicity. There may also be some very slight Rounding Errors - I have tended to Round Down in the Tables.
Tax is not included and the Growth Percentages chosen include Dividends - i.e. when I say 7% Growth, part of that is achieved from Dividend payments. It therefore follows that if you buy Stocks without Dividends then you are setting yourself behind from the start - you better be confident of your expectations of fast Capital Growth.
In all the Examples I will go for 30 years - seems a sensible number to choose. If you want more, you can add them on, if you want less, you can lob a few off !! The figures are for the End of each Year.
3% Annual Growth
Year 0 £10,000
Year 1 £10,300 Year 2 £10,609 Year 3 £10,927 Year 4 £11,254 Year 5 £11,591 Year 6 £11,938 Year 7 £12,296 Year 8 £12,664 Year 9 £13,043 Year 10 £13,434 |
Year 11 £13,837
Year 12 £14,252 Year 13 £14,679 Year 14 £15,119 Year 15 £15,572 Year 16 £16,039 Year 17 £16,520 Year 18 £17,015 Year 19 £17,525 Year 20 £18,050 |
Year 21 £18,591
Year 22 £19,148 Year 23 £19,722 Year 24 £20,313 Year 25 £20,922 Year 26 £21,549 Year 27 £22,195 Year 28 £22,860 Year 29 £23,545 Year 30 £24,251 |
Year 0 £10,000
Year 1 £10,500 Year 2 £11,025 Year 3 £11,576 Year 4 £12,154 Year 5 £12,761 Year 6 £13,399 Year 7 £14,068 Year 8 £14,771 Year 9 £15,509 Year 10 £16,284 |
Year 11 £17,098
Year 12 £17,952 Year 13 £18,849 Year 14 £19,791 Year 15 £20,780 Year 16 £21,819 Year 17 £22,909 Year 18 £24,054 Year 19 £25,256 Year 20 £26,518 |
Year 21 £27,843
Year 22 £29,235 Year 23 £30,696 Year 24 £32,230 Year 25 £33,841 Year 26 £35,533 Year 27 £37,309 Year 28 £39,174 Year 29 £41,132 Year 30 £43,188 |
7% Annual Growth
Year 0 £10,000
Year 1 £10,700 Year 2 £11,449 Year 3 £12,250 Year 4 £13,107 Year 5 £14,024 Year 6 £15,005 Year 7 £16,055 Year 8 £17,178 Year 9 £18,380 Year 10 £19,666 |
Year 11 £21,042
Year 12 £22,514 Year 13 £24,089 Year 14 £25,775 Year 15 £27,579 Year 16 £29,509 Year 17 £31,574 Year 18 £33,784 Year 19 £36,148 Year 20 £38,678 |
Year 21 £41,385
Year 22 £44,281 Year 23 £47,380 Year 24 £50,696 Year 25 £54,244 Year 26 £58,041 Year 27 £62,103 Year 28 £66,450 Year 29 £71,101 Year 30 £76,078 |
10% Annual Growth
Year 0 £10,000
Year 1 £11,000 Year 2 £12,100 Year 3 £13,310 Year 4 £14,641 Year 5 £16,105 Year 6 £17,715 Year 7 £19,486 Year 8 £21,434 Year 9 £23,577 Year 10 £25,934 |
Year 11 £28,527
Year 12 £31,379 Year 13 £34,516 Year 14 £37,967 Year 15 £41,763 Year 16 £45,939 Year 17 £50,532 Year 18 £55,585 Year 19 £61,143 Year 20 £67,257 |
Year 21 £73,982
Year 22 £81,380 Year 23 £89,518 Year 24 £98,469 Year 25 £108,315 Year 26 £119,146 Year 27 £131,060 Year 28 £144,166 Year 29 £158,582 Year 30 £174,440 |
12% Annual Growth
Year 0 £10,000
Year 1 £11,200 Year 2 £12,544 Year 3 £14,049 Year 4 £15,734 Year 5 £17,622 Year 6 £19,736 Year 7 £22,104 Year 8 £24,756 Year 9 £27,726 Year 10 £31,053 |
Year 11 £34,779
Year 12 £38,952 Year 13 £43,626 Year 14 £48,861 Year 15 £54,724 Year 16 £61,290 Year 17 £68,644 Year 18 £76,881 Year 19 £86,106 Year 20 £96,438 |
Year 21 £108,010
Year 22 £120,971 Year 23 £135,487 Year 24 £151,745 Year 25 £169,954 Year 26 £190,348 Year 27 £213,189 Year 28 £238,771 Year 29 £267,423 Year 30 £299,513 |
15% Annual Growth
Year 0 £10,000
Year 1 £11,500 Year 2 £13,225 Year 3 £15,208 Year 4 £17,489 Year 5 £20,112 Year 6 £23,128 Year 7 £26,597 Year 8 £30,586 Year 9 £35,173 Year 10 £40,448 |
Year 11 £46,515
Year 12 £53,492 Year 13 £61,515 Year 14 £70,742 Year 15 £81,353 Year 16 £93,555 Year 17 £107,588 Year 18 £123,726 Year 19 £142,284 Year 20 £163,626 |
Year 21 £188,169
Year 22 £216,394 Year 23 £248,853 Year 24 £286,180 Year 25 £329,107 Year 26 £378,473 Year 27 £435,243 Year 28 £500,529 Year 29 £575,608 Year 30 £661,949 |
20% Annual Growth
Year 0 £10,000
Year 1 £12,000 Year 2 £14,400 Year 3 £17,280 Year 4 £20,736 Year 5 £24,833 Year 6 £29,799 Year 7 £35,758 Year 8 £42,909 Year 9 £51,490 Year 10 £61,788 |
Year 11 £74,145
Year 12 £88,974 Year 13 £106,768 Year 14 £128,121 Year 15 £153,745 Year 16 £184,494 Year 17 £221,392 Year 18 £265,670 Year 19 £318,804 Year 20 £382,564 |
Year 21 £459,076
Year 22 £550,891 Year 23 £661,069 Year 24 £793,282 Year 25 £951,938 Year 26 £1,142,325 Year 27 £1,370,790 Year 28 £1,644,948 Year 29 £1,973,937 Year 30 £2,368,724 |
Tax
Note that all of these Calculations have no allowance for Tax. You may object that this is unrealistic (or even immoral - if you believe that Governments spend your money well), but I think it is very justified to excluded Tax on the basis that £10,000 is well below the current ISA Limit for one year and leaving your Money to grow in such a Tax Avoidance (Legal) Wrapper is just good sense.
However, there is of course a Huge Risk that future Governments could change the ISA rules and there is talk that a Limit of £1m could be put on the Value of Money you can have in an ISA - I guess the theory is that they would tax anything above the Limit. On a Long Term Horizon, such as 20 to 30 years, this has to be very likely to happen and could hit the Returns in the Tables above.
Already the current Government has reduced the Lifetime Limit on SIPPs (Self Invested Personal Pensions) to £1.25m. However, with careful use of SIPPs, ISAs, Spreadbets, Capital Gains Tax Allowance and Personal Income Tax Allowances, I am sure many Tax implications can be reduced.
Portfolio Management Costs
I just want to reiterate something I mentioned in passing between a couple of the Tables above.
It should be clear to you that just a couple of % changes from one Table to another have a massive difference on the Final Returns created. This clearly shows that it is vitally important to minimise your Costs of running your Portfolio. This means keeping Platform Costs as small as possible and the same with Dealing Fees and Buy/Sell Spreads where possible. You should also think of the Costs of tools such as Magazines, Tipping Websites, Software for Trading etc. etc. - all these are Real Costs and should be minimised as much as you can. If you are not getting Value and Use from a particular Magazine for instance, cancel your Subscription.
As an example, let’s say you have a Portfolio worth £100,000 and you expect to invest for another 20 Years and you are a pretty shrewd Investor and expect to achieve a 10% Return. In this case, if you can save 1% on Costs in Year 1 - i.e. £1000, over the 20 years this is £6725 Extra Return. (I worked this out by knocking a Zero off the £10,000 Starting Figure and Dividing the 20 Year figure by 10). Obviously such savings in the following Years will boost Returns considerably rather than eating away at your gains.
Think about it this way. If you have £100 of Unnecessary Cost in Year 1 and you are achieving 12% Returns per year on Average, then this will add up to £2995 over 30 Years !!!! (I worked this out by lobbing off 2 Zeros from the £10,000 Starting Figure and lobbing 2 Zeros off the 30 Years Finishing Figure from the 12% Table.)
In fact, you can apply this logic to your Wider Spending of normal life - every £100 you p*ss away on Lager could really be costing you £2995 !!
This is why it is critical to control every aspect of your Spending and to realise that if you can just save a Few Hundred Pounds more per year, it has a massive impact over time. I appreciate that if you are an Old Git like me it has less impact, but for anyone below 30 these Numbers are immense. Mind you, even for an Old Bug*er, £100 over 10 years at 12% could be costing £310.
All that money people have wasted on Lottery Tickets over the years……..what a con that is. Taxing the Dreamers…….I have never done the Lottery (I find it pretty distasteful) and I like to think that I have WON Thousands and Thousands of Quids by not wasting my Money on it. In addition, I have then gone on to Invest that Money I did not waste by Investing it at good Rates of Return.
Apologies to any Readers I have offended - but maybe I will have got you thinking about analysing what you spend. We all just let Money fritter through our Fingers and this has a Huge Cost over time.
You Must Avoid Mistakes
If you have read my ‘Rule of 72’ Blog and my Comments throughout this Blog, you should see the importance of having Realistic Expectations of what you can achieve and how vital it is to ensure you are not taking Avoidable Risks. I think it is realistic for an Individual Committed Long Term Investor to aim for 10% CAGR (Compound Average Growth Rate) per year but it is very hard to achieve this in practice.
It sounds easy, and many Readers will have done much better than this over many years recently (I know many have from various discussions) but most of us underestimate the damaging effects of the Odd Bad Years. If you have been steadily achieving 10% CAGR for say 6 years, and then you get hit 30% in a Horrible Bear Market, you will then be massively behind the Game. One Horrific Year can have terrible consequences. For this reason, it is better to not be Greedy and to aim for Steady, Tortoise Like Returns over many years and to avoid the Really Big Pullbacks - this is all about Risk Management and avoiding High Risk Gambles.
I have written extensively about Risks and suchlike - you can find Lots of Blogs on the Subject (the Position Sizing ones are pretty good here) and bits of my Website like the ‘WheelieBin’ and ‘M3 Manifesto’ can help you avoid the Duffers that will drag down your Results.
IT IS BETTER TO FOCUS ON AVOIDING DOWNSIDE RISKS THAN TO TRY TO PICK BIG WINNERS ALL THE TIME.
This is even more vital for Younger Readers - i.e. in your 20s, 30s., although it is still Important for all of us. I know that I would be considerably Wealthier now if I had not lost lots of money in my early years as an Investor. I was a bit Unlucky because I started Investing right at the Top of the Dotcom Boom - I don’t think this was necessarily Greed and stuff although that probably played a part. It was more that I happened to have a pile of Cash and needed to do something with it.
The consequence was that I lost something like 40% of my Portfolio in a few years and it is obvious from the Tables above how much this hurt me. Luckily I had the good sense (probably pure luck really) to diversify with some Bonds and Cash etc. but it set me back many many years.
The only thing I got right was that I did not give up and I made big efforts to learn what I was doing !!
IT IS CRITICAL TO REALISE THAT YOU MUST AVOID MISTAKES IN YOUR EARLY YEARS AS THEY HAVE SUCH A HUGE IMPACT LATER.
Of course, this is hard to do as, by definition, in your Early Years you are younger and less experienced, and therefore more prone to Screw Ups. You must use Resources like the WheelieDealer Website and other stuff from Experienced Investors to Short-cut your way to avoiding mistakes. Obviously reading Robbie Burn’s Naked Trader book is essential.
I wish the WheelieDealer Website had existed when I started out (Anyone for Time Travel?)
Benchmarking
There has been some recent discussion on Twitter about Benchmarks and it has pretty much followed the usual well-trodden path of selecting an Index to Benchmark your Performance against and the Ins and Outs of this. As you would expect, I have a slightly different slant on this issue.
In many ways I find this Benchmarking by Index probably not all that helpful (or necessarily healthy for an Investor’s state of mind).
Rather than using a Benchmark constructed from an Index or a hybrid version based on a couple of Indexes, maybe it would be better to make your Benchmark one of the Tables above. For example, you could decide that you want to achieve 12% CAGR year in year out and you would use this kind of Table to track your performance against. You would need to decide your Starting Cash and any Cash you add in over the years would need to be added into your ‘Benchmark’ Table calculations.
In many ways, this is more what I do in practice - for me, the problem with Benchmarking against an Index is that firstly I hold Stocks of all sorts of Market Cap sizes and from various Indexes and secondly that the Weightings I use are completely different to those that make up any Indexes - so how meaningful is it really to Benchmark against an Index? To add colour to this, consider the Nasdaq - something like 14% or so of the Index is Apple (AAPL) - how many people have 14% of their Portfolio in Apple? Would it be wise to do so anyway? Very few Indexes are Equal Weighted to the Constituent Stocks and they will not be the same as the Weightings in your Portfolio. It really is questionable how useful such Benchmarks are.
OK, there is a fair argument to say, well, if you can’t beat 7% CAGR each year (which is pretty much what the FTSE100 would probably give you if you bought a low cost Tracker Fund), then what is the point of investing in individual Stocks?
However, this perfectly logical point misses an important element for me - I actually ENJOY my Investing activities and just owning a Tracker Fund would be utterly unfulfilling for me from a Personal Achievement point of view (I guess it’s something to do with the ‘Self Actualising’ bit of Maslow’s ‘Hierarchy of Needs’ !!)
I am of the view that I enjoy my Investing and the Money that flows from it is a secondary thing - and I suggest that this applies to anything in life. If you are enjoying it and passionate about it, you will probably make Money from doing it.
By Benchmarking against an Index that is made up of strange weightings and that is an approximation at best of your Portfolio, you might be setting yourself up to fail. Just as you could probably have a run of good luck and beat your synthesised and imperfect Benchmark, you could just as easily under perform it for unavoidable reasons (that are beyond your control) and this might really knock your confidence as an Investor - never a good situation as you need to be Calm and Rational and not affected by avoidable anxieties.
As ever, it is up to you as an individual to decide what you are happiest with - but maybe the idea of a Benchmark based on a CAGR % Table might be more useful.
How to use these Tables
The point of these Tables is to show clearly how Compounding Returns over many years can grow your Wealth, and how it is vital to avoid unnecessary Tax and Costs.
In addition, these kind of Tables are a huge help in determining when you can give up Work (or reduce the amount of Work you do and go Part Time) and how much you need to Invest to achieve your Retirement Goals.
You could also use these Tables for other Assets apart from Stocks. For instance, you might have a Buy to Let Property and you could create a similar Table to work out how your Wealth could grow from this Asset. I think Property can give very good returns but it is a lot of hassle and has a lot of hidden costs that can eat away at returns. This Blog no doubt should have highlighted the impact of Costs over time.
These are the kind of Steps you can take using the Tables:
- The first thing to do is to decide how many Years you want to work for - for example, if you expect to work another 15 years, then Years 0 to 15 of the Tables are relevant to you.
- Next, you need to decide on a Rate of Return that you think you can realistically achieve. If you are an experienced Old Hand, then probably 10% is sensible and if you are particularly sharp, then 12% may apply. If you are new to the game and quite young, then maybe 7% is more applicable - remember, these numbers are for formulating a Rough Plan, if you happen to outperform, then that is Icing on the Gateau.
- Then determine your Starting Point. If you have £50,000, then you can multiply all the numbers by 5 - remember, these things are Commutative (I love using that word - I was taught it in Maths at Junior School and have never ever had need to use it since - so now, 39 years on Dear Reader, I am ramming it down your throat !!)
- Just these few Parameters from above will give you an idea of the Total Return after your Time Period until Retirement. However, you can get much more sophisticated by adding Money into the Fund each year if you think you will be saving more. For instance, you might Start with £10,000 and then add in £1000 each year after - this will take some Maths and a Calculator, but you should be able to work it out.
- Remember, these numbers do not include Inflation - and it is guesswork anyway. A good way to handle the Inflation Element, might be to drop down the Rate of Return Tables a bit. For Example, if you expect to do 12% a Year, then you could drop down to 10% as the 2% Difference might be a fair Proxy for Inflation (I believe that the true Average Long Term Inflation Rate is about 3% - so you may need to go a bit lower.)
- If you find that the Final Number you get is Lower than you wanted, then you will need to consider Working more Years, Finding more Money, or maybe how you can achieve a Higher Rate of Return - none of these are easy Options.
Anyway, I think that just about covers it. Have fun creating your Tables !!
Kali bradi, wd