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Dreaming with Compound Interest

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Dreaming with Compound Interest

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This is my new favourite thing to do; playing with compound interest calculators. Yes, it’s extremely nerdy. Hear me out.

I’ve spent ages tweaking this thing; seeing how close I can bring my retirement date – admittedly often using pretty optimistic and even unrealistic numbers. But sometimes you need to be a little unrealistic and a whole lot of optimistic if you’re reaching for a big enough goal.

So let’s look at a stupidly oversimplified example of the wonder of compound interest.

You invest a modest amount of R24 000 a year, or R2000 a month, at an equally modest interest rate of 8%, into a boring old index fund, for 20 years.

The results:

made using the compound interest calculator on thecalculatorsite.com

Notice a few things? I notice that in 20 years, you’ve not only got a million bucks, but R705,894.44 of that was interest alone. Also, your deposit amount never changed, meaning it got smaller and smaller to you, with inflation. But around year 10, your annual interest began to overtake your contribution. By year 20, your annual interest was delivering over three times that.

In myFIRE explainer post I explained the 4% rule, or 25 x your annual salary rule, for figuring out your retirement number. The number at which you’re able to withdraw 4% of your portfolio to cover your expenses, and never run out of money.

Say I wanted R30 000 a month in retirement, or R360 000 a year. That’s a pot of R9 million I need, according to FIRE math.

Is it possible to achieve 9 million? Sure – if you gave the above investment pattern another 23 years to work you’d hit 9m at around year 43 and be a very happy retiree, I should think.

But, if you’re like me, perhaps you don’t feel like retiring at 74 and feel you could do a lot better than 24k a year. By working on your savings rate and saving a lot more, faster, you’d cut that journey down by an order of magnitude.

In this mind-blowing post, personal finance blogger Mr. Money Moustache discusses the incredible impact of a savings rate on our ability to retire early. It’s very trackable; the more you save every year, the earlier you can retire because the less you need.

Okay… so I’d like 360 000 a year to live on, but maybe I only need, like, 120k. It would cover my expenses and nothing else: rent, hospital plan, transport, such as it is, maybe groceries. But that would put me at our working definition of financially independent, right?

Then I *only* need 3 million. And if I just play with the numbers a bit…

Nineteen years. And that’s on a conservative average interest rate of 8%; the Satrix Top40 ETF, one of South Africa’s most popular index trackers, delivered an average of 13.85% since its inception. That brings it down to fourteen years.

That’s something to think about, isn’t it? It’s still nineteen years, on a greatly reduced goal and saving a chonk of money every year, but… nineteen years? As opposed to forty-three. And notice the returns: with a R3 million head of steam, your money is earning a whole other person’s salary for you, every year. And it’s only going to grow from there.

Now, this is just a calculator and we can dream big dreams with the math and imagine enormous market returns. But life will be life, and there’s lots of argument to be made that 3m isn’t enough to retire on or have very much wiggle room if things go wrong.

That’s fine; it’s only a thought experiment. The question I want you to ask is: “What would life be like if my investments were carrying most or all of my living expenses?”

Try it out, with your own numbers. What would you do with all the money that used to go to rent or a bond? Where would you go? What would you turn your hand to, now that basic survival is taken care of and the money’s just quietly, slowly growing in your investment accounts over the years?

What would you do with that kind of freedom?

Article reposted with permission from Drawing Money. Original post here.

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Kay Carmichael

I’ve been a freelance artist in the film and animation industry since 2012 and I’m still alive! I am not a financial advisor nor am I legally enabled to give you financial advice. I’m a storyboard artist and a writer who’s made a lot of mistakes with money and consider myself well-read on the subject because I had to teach myself. The content on my blog is for educational purposes only and is my own experience and opinion and research.

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