Mathematics of Long Term Personal Savings

Background

I am always fascinated with the mathematics of personal savings, from the time a graduate enters the workforce, until s/he retires at the age of 60.  

I start with 4 groups of questions first:

1. Salary progression.  What is a typical salary progression of such a graduate, if s/he gets a professional job, climb his career until mid level manager and then never made higher until retirement?  How much total salaries made over lifetime?
2. EPF savings only.  If he were to only save in EPF to earn a long term interest rate of 6% per annum, how big would such an accumulation grow to?
3. Long term equity investing.  What if he supplements with long term investing, to earn 10% per annum?  How big would such an accumulation grow to?
4. Only FD investing.  What if he only save in FD to earn 3% per annum, without EPF, without investing?  How much would that kind of accumulation grow into?

1. Salary Progression

Let's consider a typical case of an "average person" who graduates, find a professional job, and work his way up to middle management/specialist i.e. not a particularly ambitious career person.

• Graduated at the age of 22.
• Obtained a professional job immediately (such as an engineer, an accountant, IT, etc.).
• Say a monthly starting salary of RM3,500 per month in the private sector.  
• Say a yearly salary increment of RM1,000 per month each year up to age 29 (up to RM10,500 per month), as he diligently work and climb up the professional ranks in a bank/multi-national organization.
• Say 5% per annum salary increment from age 30-34
• Say 4% per annum salary increment from age 35-39
• Say 3% per annum salary increment from age 40 onwards

The questions are what would the salary progression looks like?

In short, the individual would be looking to triple his/her salary by the time he reaches age 30 to earn a 5 digit salary.  After that he just cruises till retirement.  In this scenario, total salaries made is nearly RM8 million over 38 years of working!

Quite a substantial sum isn't it?

2. The Power of Saving in EPF

Let's assume that this individual made 20% savings into EPF, where 9% is member contribution and 11% is Employer contribution.

This is on the lower side, as some employers made higher EPF contributions.

Assume EPF earns 6% per annum interest historically, which is a very good long term returns.

In this scenario, how much will have this person's EPF have accumulated?  What is the multiple of the Accumulation relative to his Annual Current Salary?

Here's what it would look like:

By the time he hits age 30, his EPF balance will have grown to 200k, or 1.5 times annual salary.

By age 40, 813k EPF balance equal to 4 times annual salary.

By age 50, 2.1 million EPF balance equal to 7.7 times annual salary.

By age 60, 4.6 million EPF balance equal to 12.7 times annual salary.

Not too shabby right?  

So, what's the learnings here?

EPF is not a bad savings vehicle.  You can actually accumulate to large amounts of monies for an average person, with just EPF.  The key factor is have a good job that provides a lasting salary and time.  Without a salary and the ability to save in EPF, this avenue will not be available to you.

3. What if it's just FD savings?

What if you don't have the opportunity to save in EPF, but only save in FD?

What if you increase your savings by 50% bigger, but only sock it in FD?

Let's assume FD pays 3% per annum interest over the long term.

What does the comparison looks like?

So, over this 38 year period, total EPF savings is 1.6 million, vs FD savings of 2.4 million i.e. the FD saver saved 50% more.

However, despite saving 50% more, his accumulation by the age of 60 is smaller.

In short, not a very smart way of saving for the long term isn't it?

4. What if you learn how to invest safely?

What if you could learn how to invest and earn 10% per annum safely over the long term?

What if, instead of saving 30% of your salaries to sock into FD, you put 20% in EPF and 10% into a portfolio of very sound stocks that pays say 4%-6% dividends and the rest via price gains?

This is actually not far fetched and is very doable.  But what would your accumulation looks like?

The answer boggles one's mind!

The extra 10% savings only works out to be 808k total.
But with 10% per annum returns, it is able to grow to 4.9 million!  Exceeding EPF despite just half the savings.

The total accumulation (20% EPF + 10% diversified shares) is RM9.6 million.
This equals 26.2 years of last annual salary drawn.
This should be able to last for a lifetime - even if you retire at age 60 to live up to a ripe old age of 100.

Summary and Conclusion

1. It is possible for an average person to accumulate a massive amount provided there is discipline and commitment.   It starts with having a good, stable job.

2. Then, the habit of saving something everytime.  If you start saving as soon as you graduated and learn how to live within your means, the first year is the hardest, but after that, the rest becomes habitual and easy.  Learn good habits early.

3. Then, save in EPF to earn 6% per annum long term interest.

4. Then, learn to invest safely in equities to target 9%-10% per annum long term interest.  Here, the strategy is simple - invests in a diversified stock where the underlying business is good, generally grows its EPS, DPS and Net Assets over long periods of time, aim for stocks that pays at least 3%-6% dividend yields and grows them sustainably.  Diversify to 20-30 of such stocks.  Buy them when the price is lower.  Basically, learn from Warren Buffett (who achieved so much more than 10% per annum).   Dividend stocks with a long history of paying out dividends to shareholders are generally safer - they may be boring, but with commitment and discipline, you can amass a good fortune over your lifetime.  And this strategy is scaleable - you can do this with 100k, 1 million or even 10 million.

Final Reflections

The thing with time, is we all have the same amount of time everyday that we are alive.
(if we die earlier, it doesn't matter that we die broke, because we'll be already dead).

The thing with living a long life, is that we only have 1 shot at life to make monies when we are in our productive years.
(squander this, and your old age will be miserable).

Live a good life, enjoy life, but put aside some monies too for the future (and make that opportunities count, because if you plan to invest for 20, 30, 40 years, you probably only have 1 shot in your life to do this).