Home' Trinidad and Tobago Guardian : October 6th 2016 Contents Beginning with the end in mind
We need to establish the capital sum required to fill his retire-
ment gap of $5,000 per month (in today s dollars). Assuming
an annual inflation rate of five per cent, Winston has to collect
$7,500 per month to have the same purchasing power in eight
years time. Assuming that his investments in retirement earn
a return of five per cent per annum, Winston would need to
accumulate $1,800,000 ($7,500 x 12 = $90,000 / .05) by the
time he is 60.
Projecting future investment values
If he adds nothing further to his credit union account he
should have $440,000 at retirement. The gap would now reduce
to $1,360,000 ($1,800,000 - $440,000). We now need to see
if Winston s expectations of funding this gap with his stocks are
realistic. To do this it would be helpful to know how they have
performed to date and then extrapolate these returns over the
next 8 years. This, of course, would only be an educated guess
as no one can predict the future values with any certainty.
Our approach will be to compare the value of each stock
investment today in terms of current prices and reinvested div-
idends against the original investment. Knowing what the annual
dividend payments were and the rate of return on the credit
union that they were invested in, we could calculate their present
At this point we would have calculated the historical annualised
rate of return on each stock from the point of purchase to the
present. We must then look at what proportion that stock
occupies in the entire portfolio and then use this percentage to
calculate a weighted average annual return by multiplying its
historical annualised return of each stock by its percentage of
the portfolio. Adding up all the weighted average returns of each
stock would give us the overall portfolio performance and enable
us to project its future value and see if Winston can really hit
To demonstrate we will look at two companies and then the
complete picture afterwards.
ABC Company: 10 years ago Winston invested $40,000
($20.00 x 2,000 shares) in this stock, at present it has a market
price of $50.00 so his investment is now worth $100,000. He
collected an average annual dividend of $1.00 per share, which
he invested in the credit union at an assumed 5% per annum.
The total of dividends collected is $20,000 ($1.00 x 2,000 shares
x 10 years) so with returns the present value should be $25,156.
The combined present value is $125,156, which means his
investment grew by $85,156 ($125,156 - $40,000) over 10 years.
This translates to an annualized rate of return of 12%. Now ABC
including accumulated dividends represents 41% of the total
portfolio value of $306,627. The historical weighted average
annualised return of this stock is thus 4.93% (12% x 41%).
Two years ago he invested $97,500 ($15.00 x 6,500 shares)
in this stock, which has a present market price of $7.50 making
this investment $48,750. The average annual dividend was $0.75
per share so he collected a total of $9,750 ($0.75 x 6,500 shares
x 2 years), which when invested at 5% per annum should be
worth $9,994 today.
The total present value of this investment is $58,744 ($48,750
+ $9,994). This investment lost $38,756 in value ($58,744 -
$97,500). This translates to an annualized historical rate of return
of negative twenty-two per cent (-22%). MNO represents 19%
of the total portfolio value ($58,744 / $306,627) so its historical
weighted average annualized return is negative four point two
nine per cent (-22% x 19% = -4.29%).
When we combined all of the stocks the overall portfolio
return was a modest 2.27%, where three stocks had positive
returns and two, negative. Even though Winston lost money
with two stocks, the increases in the other three compensated
and produced an overall positive result. As of today he achieved
a total growth of $64,377 (present value: $306,627 minus $242,250
The Best Strategy
A wealth increase of $64,377 is not bad but when we consider
the time value of money (TVM) it tells a different story. Winston
needs to seriously contemplate his options at this point. If he
decides to hold out and if the stock portfolio continues on its
current trajectory he would have $367,624 in 8 years time.
Applying this value to the residual gap above he would now have
a shortfall of $992,376 ($1,360,000 - $367,624).
Because of the unpredictability of the stock market Winston
may want to consider a more conservative investment posture
with a focus on preservation of wealth. Now of course safety
usually translates into modest to low returns but Winston may
be able to get the best of both worlds; a certain investment with
higher returns than he is earning at present.
Investing in debt:
On the one hand Winston is faced with an uncertain low
return of 2.27 per cent on his stock portfolio and fairly certain,
moderate return of 5% on his credit union shares. On the other
hand his cost of funds on his mortgage is 6.65 per cent (TVM:
$260,000, 8 years, $3,500 monthly) and on his credit union loan
is 12% (1% x 12 months). His financial assets (excluding property)
are earning less than his debts are costing him, effectively losing
Bringing the balances together he has a net debt of $210,373
(Total debt: $552,000 credit union + $260,000 mortgage =
$812,000 minus Total financial assets: $295,000 credit union
shares + $306,627 investment portfolio = $601,627). He also
has a heavy monthly debt load of $12,472 ($8,972 + $3,500).
Winston can completely eliminate the burden of his credit
union loan by liquidating and using part of his stocks in com-
bination with the credit union shares. He would need $257,000
($552,000 - $295,000) from his stocks to reduce the loan balance
in line with the shares then offset the two. This frees up $8,972
of monthly payments.
He would be left with $49,627 ($306,627 - $257,000) in stock
investments, which he can then use to reduce his mortgage
balance to $210,373 ($260,000 - $49,627). He can then combine
the previous credit union installment and the mortgage payments
($8,972 + $3,500 = $12,472) to eliminate the remaining balance
in eighteen months (1½ years). He would be debt free 6½ years
before retirement over which time he can restart his savings
monthly by the same $12,472 at five per cent per annum and
amass $1,146,715 by age 60. This doesn t completely fill his
retirement gap of $1,800,000 ($1,800,000 - $1,146,715 = $653,285).
Now if his property, which is valued at $970,000 today, appre-
ciates at the rate of inflation of five per cent per annum it would
be worth about $1,500,000 by age 60. His total net worth at
that time would be $2,646,715 ($1,146,715 + $1,500,000). He
has to put this wealth to the best possible use to secure his
projected (inflation adjusted) retirement income of $7,500 per
If he were to sell his apartment at that time with the intention
of moving back home, he would be able to purchase a rentable
two-storey house; live upstairs then rent the ground floor. Based
on property prices in the future what would he be able to buy?
A future net worth of $2,646,715 is the equivalent of $1,731,871
today, which falls within the present range of the properties he
is looking at currently.
Assuming that the rental rate of return on property investments
is also five per cent per annum half of his future property could
generate about $5,500 per month ($2,646,715 x 5% x 50% =
$66,167 / 12 = $5,513). He would be still be short of his targeted
future income by $2,000 or a capital equivalent of $480,000
($2,000 x 12 = $12,4000 / .05) but it would certainly be an
improvement on the gap of $992,376 above.
Winston might further improve his financial position by selling
off everything, clearing his debts and starting over with the value
of his net worth as a down payment (assuming he qualifies for
adequate new mortgage financing) on a two-storey house, rent
downstairs and use the income to subsidise part of his mortgage
Whilst the mortgage payments are relatively stable the rent
would increase at inflationary rates.
Net worth: $756,627 (Assets: $970,000 + $292,000 +
$306,000 = $1,568,000 minus Debts: $552,000 + $260,000
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OCTOBER 6 • 2016 www.guardian.co.tt BUSINESS GUARDIAN
FINANCIAL ROAD MAP | BG17
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