The answer to the question above, like the answer to so many of life's most important questions, comes in the form of an equation. Luckily; unlike many of the other important equations, this one is rather simple. However, you must take care not to allow its simplicity to fool you into believing that it is less important than the more complicated equations fighting for their moment in the spotlight. This particular equation is possibly one of the most important equations ever! Well, maybe not ever, but you get the idea. It's pretty important.
So what is the equation? Well, this:
(monthly expense) x 20 x 12 = (required amount to fund monthly expense indefinitely)
That seemed simple enough.
There are however a few underlying assumptions that need to be pointed out here. The result of the equation being "required amount to fund monthly expense indefinitely", is not a big pile of cash. Not at all. This is the amount that you will need to grow at the rate of inflation AND yield 5% income from, every year, in order to fund the "monthly expense" indefinitely. The capital amount needs to be invested in something that will keep up with, or outpace inflation (hint: it's Equities) as well as yield an income of 5% per year (hint: it's Equities) or the capital will simply run out. And sooner than you think, especially with inflation working against you. Therefore for the sake of simplicity, it can be re-written as "required portfolio size".
Ok, so now we have the groundwork done. Let's put something in the equation and see what it does. Let's say that you are an individual that likes the outdoors and sleeping under the open sky (come rain or shine). Luckily, you already have warm shoes, a few blankets and a nice Shoprite trolley; so all you really need is bread and milk to stay alive. So that comes to what? R 25 a day, or R 775 per month. Ok, here we go:
R 775 x 20 x 12 = R 186 000
And there you have it. R 186 000 will allow you to spend R 775 per month for the rest of your days. Provided that it is growing at least at the rate of inflation and generating income equal to at least 5% of the total capital (being R 186 000). Each year your capital base will grow and your 5% earnings will be proportionally bigger, so you will not get poorer as time goes by due to inflation. You will be able to buy a bread and some milk every day despite the affects of inflation eroding the buying power of your money. That sounds pretty secure. Although, somehow I don't think there are too many 'out-doorsy' types reading this blog. So lets use a "monthly expense" base that is a little bigger, so that we may allow for a small apartment and say, R30 per day for food.
So lets see, a small apartment is what, R 3 000 per month? Ok, we'll say that includes water and electricity. Then R 30 a day for food is, well, a modest budget of R 930 per month for groceries. I think we'll also add a R 250 cellphone contract in here for good measure; you know, so you can stay in touch with your loved ones and all that. So that totals R 4 180 per month. Here goes:
R 4 180 x 20 x 12 = R 1 003 200
A million Rand. Wow. That can't be right can it? Let's see... R 1 003 200 x 0.05 (5% yield) / 12 (months) = R 4 180. Yep, it's right. R 1 003 200 yielding 5% a year will provide enough income to sustain expenses of R 4 180 per month. Again, it is vitally important that this capital base is invested in something that will provide this sort of income/yield (5%) as well as grow at the rate of inflation or you will become poorer with every passing year as inflation erodes the value of your money over time (hint: it's Equities).
By now I am sure that you are getting the picture. To some reading this; retirement is still a far off problem for the future, and to others it is a sudden and chilling realisation that they are not prepared at all. Regardless of which one of these two you are, you need to start saving, no, investing for your retirement right now. There is no other way.
If we bump the "monthly expenses" up to something realistic, the numbers start getting scary. Let's say your monthly expenses come to R 9 000 per month (which by all standards, is not really very much) and you wish to maintain your current lifestyle during retirement. What are you working with now? Let's see; same house as above, maybe R 1 400 worth of food now, car insurance (old cheapy but hey, it's paid off) for R 1 000, medical aid (old people need these) of R 2 500, cellphone of R 500 and R 600 worth of petrol (which is only 1 tank if you think about it).
R 9000 x 20 x 12 = R 2 160 000
If you want to retire on R 25 000 per month, you can imagine that the number gets a lot bigger. Fear not, for there is a solution. Can you guess what it is? By now I sincerely hope you can, but where do we begin...?
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