## Tuesday, April 14, 2009

### Can 12% return cope with 3% inflation ?

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If you have an investment that consistently gives you a 12% return while you have been controlling your own personal inflation at 3%, would that mean you are financially free forever ?

The first trick you may think off could be the actual amount of money involved. For example, a \$100 12% investment will never be able to cope with \$200 3% inflation. But in this case, the investment amount starts at \$567,803 and the annual living expense is \$53,915.

So do you think a 12% return from \$567,803 is able to substain 3% inflation on \$53,915 ?

This is actually the 3rd part of Gabriel's story. ( part 1, part 2 )
If you are one of those who cann't believe 12% return is still not enough to substain even 3% inflation, then buckle up and stay very close to this blog as you may not believe still how under educate we all are in our personal finances.
As shown in part 1 of the story, this is the projection to the question above.

and these are the first few years of calculation:

\$53,915 inflated 3% becomes \$55,532 next year. \$567,803 with 12% return becomes \$635,939. Minus out the \$55,532 becomes \$580,407. These are the numbers for subsequent years.

Everything seems fine as the total investment capital keeps growing.

However ... things start to change about 15 years later when annual expense reaches \$83,997 and capital changes from \$692,754 to \$691,887; marking the end of capital up trend.

As you can see, the investment capital is rapidly deprecating after that until it completely disappears 30 years later.

So a 12% return on half a million can only substain a 3% inflated \$50,000 for 30 years! 30 years is VERY far from eternity at all.

The case is quite ok for Gabriel because he is already 68 years old now and he has another backup fund other than the numbers shown here. But if this is a total retirement plan for a 30 years old person, this will only last him until 60 years old. Not to mention the potential short fall on the 12% return in some years and 3% inflation seems like a very tough target for a 30 years old person in today's environment.

Consistent 12% return is very close to the top performance you can ever get. (imagine Warren Buffect's average return from 1999 to 2007 is 9.23%). And a 3% inflation comes with very little hobby life style and I would consider it far from luxury. So even the best return can only last the most controlled life style for 30 years

Just like how other articles have been emphasizing, put down ALL your numbers on a paper, not just look at the overall concept or just the interest rate. Every case could bring a different result but if you look at the real numbers, you will put all other doubts and tricks away.

( part 1, part 2 ,part 3)

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