Saturday, June 18, 2011

Compound interest

Early retirement is not my goal, since I don't have these kinds of sums to spare. However, it is a common goal in many investment blogs and a fun scenario to speculate.

This calculation is from Coder's investment blog. You save 10000€ each year and get the historical stock market average return of 8%. It doesn't take inflation into account.

1. year: 10 000,00€
2. year: 21 600,00€
3. year: 34 128,00€
4. year: 47 658,24€
5. year: 62 270,90€
6. year: 78 052,57€
7. year: 95 096,78€
8. year: 113 504,52€
9. year: 133 384,88€
10. year: 154 855,67€
11. year: 178 044,12€
12. year: 203 087,65€
13. year: 230 134,67€
14. year: 259 345,44€
15. year: 290 893,08€
16. year: 324 964,52€
17. year: 361 761,68€
18. year: 401 502,62€
19. year: 444 422,83€
20. year: 490 776,65€

Notes about the series:
  • In the end, the yearly gain is 40000€. The tax percentage is about 27% (assuming 1/3 dividend income with tax percentage 20% and 2/3 capital gains income with tax percentage 30%.) This is quite well-off.

  • In the beginning, savings dominate. The faster you can save the first 100000€, the better. Speed up the process by living with austerity for some years.

  • In the end, interest dominates. Around year 10, interest and savings provide equal boost to capital. At year 15, you might just as well stop saving and concentrate on researching means to increase interest.

  • If you take inflation into account, you have to wait a few more years. A comment in the original blog suggests 2% inflation, which would require waiting 4 more years to get the same real income.

  • After 10 years, you can already live on 1000€ a month. Then again, social benefits allow that much faster at the next round of layoffs if that is what you want to do with your life.

  • At around year 15, getting laid off is a lottery jackpot. With income-based unemployment benefit and stock-market gains together, you earn the desired yearly sum much earlier while waiting the compound interest to work its magic a little slower.

  • If you plan to retire to a low-paid meaning-of-life work, the right time to switch is around year 12. At that point, the main thing left to do is to wait. Saving has little effect. You might just as well start the lifestyle adjustment, as long as you don't touch the capital.

  • If you are near retirement, you need less. After retiring, you only need to make (desired income - pension). Before retirement, you can eat on capital as long as you still have enough at the point of retirement.

Why this is not my way

Social deprivation and lack of externally imposed structure would drive me crazy. I experienced some of it during the two summers spent writing my own website. I talked to other people once a week and went to sleep at 6am. I am the kind of dog who needs a little whip sometimes.

This calculation horrifies me and falls to the category "be careful what you wish for, since you might get it."


Tiedemies said...

10K p.a. is not too much; if you gross 4K p.m., your net income at current tax rates is about 2.7K. Saving €830 p.m. leaves one with about 1.9K p.m. Hardly a sum that causes social deprivation.

_I_ don't make 4K, but unless _you_ do, you've got yourself a bad deal.

Simo said...

It was not the lack of money causing social deprivation, but the fact that I had not yet discovered Game of Talking.

How much one can save depends on one's spending habits. Those who live from hand to mouth save 0 euros a month. Jacob of Early Retirement Extreme saved over 75% of his income. For others, the monthly savings rate is somewhere in between. It is not wise to discuss them directly in Finland because of envy towards those who save more and contempt towards those who save less.

Thomas Watson said...

I know a lot of people who would retire early if their health care was really affordable.