The good news is that it can be done - provided that time is on your side. The bad news is that you aren't going to do this by playing safe! The most important factor that you will need to consider is your appetite for risk.
- Are you willing to gear your investment against other assets you own?
- Is this R500 per month your only disposable income or is it a mere drop in the bucket to you?
- Are you someone in their twenties or thirties who can afford high risk because they have time on their side, or are you in your forties, fifties, or sixties with limited time on your side?
Ideally you're a young person with a high disposable income for whom R500 per month is a pittance! Nevertheless, you could also be an older person with an even higher disposable income who is willing to invest more than R500 per month!
Unfortunately, if your plan is to turn R500 per month into a R1 million it's not going to happen anytime soon, and it's also not going to be as a result of playing it safe and investing in cash!
Here are some examples:
Investing on the Stock Market
According to the Allan Gray website, the JSE All share index has delivered an amazing return of 19,4% per annum from 15 June 1974 to 30 September 2007, which is the last 33 years!
Unfortunately there are two factors that you will need to consider:
- Firstly, that this is all historical and isn't a promise of future returns
- Secondly, that no one out there is going to invest your money free of charge!
So let's be conservative and wipe out 9,4% of that return which leaves us with a mere 10% per annum return. Now a flat R500 per month invested for 30 years at a constant 10% per annum growth will provide you with R1,139,662!
"But surely," I hear you say, "if you've calculated that you can earn R1,139,662 in 30 years, then I'll reach a R1 million a lot sooner?"
Aha, remember that the stock market doesn't always offer positive returns! In fact, in the period mentioned by Allan Gray above, eight out of those 33 years were negative!
Now here's the really bad news...
Let's assume that inflation runs at 8% per annum over those 30 years. That would mean that your R1,139,662 would only be worth R104,214 in today's money after 30 years! That's less than what you would have paid in (30 x 12 x R500 =R180, 000).
In order to save a R1 million in today's money (at 8% per annum inflation), you would need an in your pocket and after expenses return of 19,80% per annum! And that's the simple reason why you cannot afford to be in cash.
Investing in Equities
For someone who has 30 years ahead of them before retirement, and who can afford the R500 per month investment required, considering a general equity unit trust fund wouldn't be the worst choice for the first 20 years.
Borrowing and Investing Against your Assets
And for those with sizeable assets, high disposable income, who have time on their side, and a large appetite for risk...
Considering that the R1,139,662 that you will receive after 30 years by saving R500 per month is only worth R104,214 in today's money, what if you were to loan this amount on your 20 year mortgage and then invest for the 30 years upfront? Would you believe that your return (at 10% per annum) shoots up from R1,139,662 to R2,067,346!
At a prime rate of 14,5% per annum you would repay R215,937 in interest over the 20 years. R2,067,346 less the R215,937 gives you a return of R1,851,409 which still beats the recurring monthly investment by R711,747!
This means that you would only need an in your pocket return of 16,46% per annum to get a ‘real' million in your back pocket!
Of course, there is that little matter of timing if you plan on going this route. Make sure that when you do this that you are in a definite bear market. Nothing will bring tears to your eyes faster than seeing your R104,214 lose R20, 000 overnight! That would all but wipe out the benefit of going this route.
Invest in Your Property
If all this sounds too much like high risk, then why not put the extra R500 per month into your bond?
On a R1 million bond at the current prime rate of 14,5%, you would end up spending R2,071,991 on interest repayments over 20 years! By investing an extra R500 per month into that same mortgage, you could reduce your bond term from 20 years to 16 years and 8 months. Even better is the fact that your interest repayments drop to R1,648,357, which amounts to a saving of R423,634!
"So what! After 16 years and 8 months I've only saved R423,634!"
Don't forget that you will own outright an asset which was worth R1 million when you bought it 16 years and 8 months ago. Now if ABSA's house price index (February 2008) is anything to go by, we can safely assume that your home would then be worth R4,269,849 (9,1% nominal return for January 2008).
Not a bad investment for an extra R500 per month, don't you think?
(This article doesn't in anyway constitute formal advice, but is rather an opinion. You should always seek a professional opinion before making an investment decision of any nature.)
Lawrence Blake, Independent Financial Planner, Blake & Els Wealth & Risk Management, Licensed Financial Services Provider.
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