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My big goal is to have a portfolio value of $300,000 by the year 2018. The question is, what is it going to take to get there? How much money do I need to save on a monthly basis and at what portfolio return do I need to see? Of course, the amount I need to save monthly is dependent on the return. If I achieve a high return, then I do not need to put as much away. On the flip side, the more money I can contribute the less dependent I will be on a high return. One thing is constant though – I want to have a portfolio value of $300,000 by 2018 and I need to figure out how I am going to get there.
As an MBA student a number of years ago, one of my finance courses looked at the concept of scenario planning. Scenario planning involves testing different strategies against a series of alternative futures. In my example of figuring out how I am going to get to the $300,000 I set up four different alternative futures, each with a different rate of return (ROR). I chose the ROR as the variable because it is not something that I can control. Of course I need to ensure I am making smart stock picks and sticking to my chosen asset allocation to manage risk, but I cannot control what the market does and what return it gives me. The only input I can control is the amount of money I put away on a monthly basis. Depending on which scenario I beleive most likely to occur, I will know what I need to be budgeting for every month. Here are the results for each of the scenarios:
Assumptions:
Current Portfolio Value (Present Value): $60,000
Desired Portfolio Value (Future Value): $300,000
Number of Payments (12 months X 10 years): 120 months
Interest Rate Per Period (12 months divided by interest rate): Variable
Payment at Beginning of Period
Note: I know that dividing a yearly rate of return by 12 to get the rate of return for each month is not mathematically correct – it does serve the purpose I am trying to complete here. Each of the scenarios were run using the online calculator at Finance Calculator Version 4.0. In addition, this does not take into account inflation and assumes a constant rate of return. I am sure there are more mathematically complex ways to do this but for the purposes of this excersise I beleive that this is adequate.
Very Optimistic Scenario
For the very optimistic strategy I am using a rate of return of 14%. As we know, the average stock market return is approximately 11%. If things went very well over the next 10 years and I managed to blow away these average returns and achieved 14% in each of these years I would only need to contribute $224 per month to reach my goal of $300,000.
Click to EnlargeAverage Scenario
In the optimistic strategy, I used a 11% rate of return which means I would meet the average historical returns for the U.S. market. If this scenario played out, then going forward my required payments per month into my investment accounts jumps to $551 per month. That is a big jump from the $224 required with a 14% rate of return.
Click to EnlargeBelow Average Scenario
I call this scenario below average simply because it is lower than the average market performance in the last 80 years. The rate I chose was 8%. At 8%, the amount of money required monthly to reach $300,000 is $905. Again, this is a big jump from the 11% rate of return amount required.
Click to EnlargeVery Pessimistic Scenario
The very pessimistic scenario would not be much fun. If the markets acted like this there would be some bigger problems in the world. The rate of return I chose is 5%. This could easily be obtained by looking for some high-yield savings account. The point is that if I am only able to achieve this ROR, then I would require a monthly savings of $1,290. That is a lot of money given that we are a one income family with two kids.
Click to EnlargeWhat is My Strategy Going to Be?
I struggled with this a bit as it is very difficult to predict the future. What I decided was to project an 8% rate of return over the next 10 years which means that I need to start saving $905 per month. Now I need to go and rearrange some things in my budget to make this happen…
(Photo Credit: Trine de Florie)
I think 8% is still very optimistic. I think you need to adopt the worst case cenario to improve the odds of attaining your goal.
The S&P expected return is 7% on TTM basis (5% earning yield + 2% dividend yield) so 8% might be a bit of a stretch.
I think inflation likely won’t be insignificant given your 10 year outlook. You are already seeing significant changes in your monthly investment requirements due to small changes in rate of return. One thing you could do to quickly account for inflation would be to lower your projected annual rates of return by 3% (or whatever you estimate inflation to be). This should give you a clearer picture or one that at least errs on the side of safety.
Great job figuring out your plan though. It’s an important first step to achieving your goals. Good luck and thanks for sharing!
Peter
I’m curious as to where you got the $300k figure – is it significant or is it just an arbitrary number?
Mike
I like your analysis. At this stage of my life $300K sounds like a lot of money, but it seems so easily obtainable when you lay out the plan like that.
I think 8% is a good, conservative plan. Since you only have a 10 year time frame you will be subject to a lot more volatility so it’s probably best to go with the lower figure, even though you should be able to beat that over the long term.
It seems that inflation must be accounted for, unless you just want $300,000 in 2018 dollars. If not and you want $300,000 in 2008 dollars then I would just take 2% off of your expecte return.
By the way, great calculator, I think I am going to use it to determine my mid term goal as well…
If $900/month is currently not in the budget, you could add another variable, annual increases which could be tied top your expected salary increases, then solve for what your starting contribution needs to be. Given the uneven cash flows, this would be tedious on a financial calculator, but would be short work for Excel using the Goal Seek option.
I love goals and plans. If you don’t plan, then you plan to fail!
Best Wishes,
D4L
Or if annual increaseas are anticipated you could cancel that out with inflation (ie 3% increase annually and 3% inflation) and assume your end value is 2008 dollars.
Nice work. It is tough to come up with a model that takes into account dividend return, inflation, stock appreciation, etc. Giving a general rate of return seems like a decent compromise. To me, it all comes down to building a simple model for myself and then checking it against actual performance.
-Jake
DivGuy,
I was just wondering what annual income do you expect to achieve from those $300k by 2018? And just like FourPillars I was wondering ,why stop at 300K? Once you are at such an amount, it would take you only a 33% to reach 400K, which in an optimistic scenario is about 2 years.
I don’t know for sure, but it doesn’t sound like he’s stopping at $300k – that’s just his goal by the year 2018. Once the goal is hit, I’d imagine it’s time to set a new goal.