Sunday, January 2, 2011

What better post to start the year. How to get rich!

There are many ways to get rich and they all require patience, a cool head, and luck. We have over the last year discussed many aspects of investing and I feel we’re at a point that maybe we should take a step back from the details and look at the overall picture. So suppose, you save $10,000 per year and you are 30 years old. What will you be worth when you are 55 years?

 Using the after tax and after inflation returns of our posting: “After Tax and Inflation Returns on Stocks ”  you would have accumulated 25 years from now $578,000 in today’s after tax dollars and if you waited another ten years, when you’re 65, your portfolio would be worth $1.2 million dollars (see spreadsheet below).

Would that be enough to live off for the rest of your life? There are some considerations because our investment returns are based on long time investment horizons. So if in the year after your retirement at age 55 or 65 the stock market crashed would you want to be forced to sell stock? Probably not!

Consequently you would have to ensure you have enough cash flow from dividend income or fixed income to live off . If dividend income would be insufficient you could consider divesting into fixed income but that would reduce your overall ROI. If you held real estate you might be able to augment your cash flow that way. But for now let’s assume that you have to live of  the 2.5% dividend yield then, using the earlier portfolio valuations, your annual cash flow would be around $13,000 when you’re 55 or of $33,000 plus CPP if you retired at age 65.

With that amount of income you are not likely to consider yourself very rich. Now if you had saved every year $20,000 you would have accumulated at 65 around $2.3 million or an annual income of $58,000 plus CPP. That should not be too bad; especially because this income would be mostly tax free. But then, saving $20,000 from an annual income of $70,000 would probably mean that you have to lead a pretty frugal lifestyle, especially if it involved being married and raising two children.

Figure 1. Simplistic Wealth Planner spreadsheet using after tax and after inflation returns. Note the black line in the middle hides the rows from year 3 - 23.

If your household income was $100,000 and you saved $30,000 per year, then by age 65 after 35 years of perfect investing, you’d likely own $3.4 million or $1.7 million in today’s dollars at 55. Hmm, that comes closer to financial independence, wouldn’t you think? But would you call yourself rich?

What we’re doing now is nothing more than simple financial planning. We’re doing ‘what-if’ scenarios. It also becomes clear, that your salary or self-employment income better increases quite a bit over the years if you want to become really rich. With a $100,000 annual household salary it is tough to become a deca-millionaire!

It is clear that you need some breaks if you really want to achieve that level of affluence. This is where it becomes very important to be on the look-out for real breaks or opportunities in life. Most of us will experience hard times but we also will experience some pretty good opportunities. The art is to get unharmed (or as little harmed as possible) through the bad times and to grasp those opportunities that will make us ultimately wealthy. In the coming posts we’ll be talking about some of those opportunities – it is intended to show that you may have several of these chances – you just have to able to grab the right ones.

No comments:

Post a Comment