Thursday, November 09, 2006

How to make a million just by growing CPF alone and achieve an ability to spend $6000 of today's value monthly till age 80?

This is a follow up on the earlier article I wrote about if saving a thousand every monthly is enough and maybe a bit controversial because ultimately the outcome depends sorely on the mindset of the practitioner. Some of you out there may think this is a frightening fact that a saving a thousand is not enough in my view if grown at a normal interest rate. Moreover, I must admit it is probably a bit too tough for most average people. But as always, there're ways and alternatives around it.
Here's one way. You always still have your CPF to invest, i.e you do not need to come out with cold hard cash. Anyway, this is a case based on a person who is earning 1) $2000 a month for the rest of his working life and 2) having a $10,000 capital in CPF to start with to invest 3) at the age of 29 and 4) at an average compounded return of 15% yearly. These are the 4 impt variables in the calculation. Anyway, I think this probably does not represent the average educated Singaporean income which is sure to be more than this at age 29 on average. So if a worst case scenario can grow his CPF to more than a million at age 55, you can imagine the magic the others can do who earns much more.
If you invest the $10K of initial capital you have at age 29 and every year, you also pump in whatever that is available to you in your CPF to invest (you will have about $2574 every year). You will have an available fund of $1.13 million (present value of about $663,000) at the age of 55. This is excluding the amount which CPF does not allows you to invest (you can only use about 30% of ordinary account to invest in stocks), thus, your CPF funds by then will have more than $1.13 million. Add maybe about 200k more??
With this fund of $1.13 million, you can afford to spend up to $6500 of today's value per month if a person life span is up to 80. But in the last year, you will be in negative equity. By then, the $6500 of present value will equate to $11k when you reach age of 56, and $18K when you reach age 80.
In fact, if you spend $5000 monthly, your fund will always be ever increasing because your yearly returns is more than your yearly spending.
Anyway, to achieve 15% return is not that easy or difficult, even if you think you can't achieve 15%, I think 8 to 12% is reasonable and that will give one a pretty comfortable life by then when one retires till one is gone.
So if you have the discipline, even without investing or saving from your own hard cash, and you do it purely through CPF, you can achieve wonders from a simple way of disciplined investing.

For the benefit of those who think 15% return annually is too much, I shall provide you how much 8% yearly compounded return will be worth in the same scenario. At 8% yearly, your fund at age 55 will be worth about $302,000 (present value of $$177,000). Anyway, I think most educated people earnings will be more than $2000. If you earn $3000 and the yearly return is 8% and calculated based on the same method, the fund by at age 55 will be about $415,000 (present value of $241,000). If your earnings is $4000, it is worth about $525,000 (present value of $307,000).


fishman said...

Interesting calculation. I assume that in your scenario, the strategy that one is to use will be dollar cost averaging?

You know I'm really skeptical how useful and reliable the method is. I have no doubt there's a high chance that positive returns will be achieved, but is it possible to hit 15% per annum?

Based on history, a person who invest that long will probably meet 2-3 market crash during the period of time he's invested. How will this affect his returns then?

Berkshire said...

Hi Fishman, frankly, I'll never advise any one to use the dollar averaging method. In any case, I regret that my article somehow mislead others into this.

In essense what I meant is to have a correct mindset. This mindset is particularly referring to the way of value investing (be it the total Ben Graham method or the Warren Buffett method).

Then the calculation that was mentioned where the average that is pumped in yearly is just an average. What I meant is you do not have to forced yourself to buy each and every year with the amount that has been set aside.

For a simple example, if you have $10K today. And you consider the following 2 scenarios.

For the 1st case, if today you manage to find a bargain stock and manage to double up your investment in 5 years. That is about 14% compounded year. (Btw, if you want to roughly know how many years it takes to double up, the rule of thumb is to use 72 divide by the return you estimate you can earn. Conversely, if it takes 5 years to double up, to find the return, 72 is divided by 5 years to get 14% roughly)

For the 2nd case, let's assume from today up to the 4th year, you can't find any bargain stocks and only manage to find one somewhere in time during the 4th year. And you manage to double the $10K when it reached the 5th year.

In both cases what is cleared is the results are the same for the $10K investment.

In the second case, the investor does not force himself to buy a stock when he can't find any bargain. He waits for his chance.

I dun know if you get what i meant. This article is actually just an average whereby some years, you make alot of investments, some you do not or may even be totally out of the market. But when you average out everything, it is an average.

But in dollar averaging, the method is to invest no matter what the condition of the market.

15% return is only for people with the correct mindset, not for people who goes after what the market tells them to go after. Not by listening to any other. You have to be able to make your own conclusion on what is a bargain.

When someone tells you that the market average is say 8% yearly on average for the long run. You may be skeptical when someone comes up to you and say it is no problem for him to do 15% in average for the long run. But it is true that there will be people who will achieve 7% more than the average (8%) market performance. and there will be people achieving much lesser than the market average.

Let's say there are only 100 people in the whole market from then to now. And the market performance is 8% for these 100 people. Out of these 100, 50 have an average of the market performance, i.e 8%. And then 25 have 15% and the rest, they make up the balance. And what is the return of the rest of the 25? They went no where with their investments. So in anything, the average of anything is just an average where there are people who just manaage to be average, people above the average, and people well under the average.

Simple logic and the thing that determines where you stand is your mindset and fundamental in finding the right method that is consistant in giving you a consistant outcome.

A bad method which is consistant will consistantly give a bad outcome. It works conversely if you have a good method.

fishman said...

I actually think I understand what you were trying to say!

Fact is this is real life; no right or way, just many paths and ways to reach that ultimate goal (and everyone have different goals!).

And I agree that eventually those who can reach their goal faster or easier will be those with the right fundamentals and discipline to stick with their choosen strategy.

I don't really like dollar cost average 'cos I feel it's really brainless and you don't learn anything except passin money to someone else, hoping it'll be in good hands and grow over the years.

But every strategy has it's reason of being and purpose. So it might still be suitable for some, yet not others...