Date: 20 December 2020

Short answer: No, but better.

To answer a question, we always start by making some assumptions, including Starting Salary, Inflation Rate, Salary Growth Rate, Salary Growth Rate, Expense Ratio, and Return on Investment.

I am putting this calculation in the Hong Kong context and a typical university graduate salary:

Starting SalaryHKD 19,000.00
Inflation Rate0.03
Salary Growth Rate0.06
Real Salary Growth Rate (Salary Growth Rate – Inflation Rate)0.03
Expense Ratio (The percentage of the salary you have to spend)0.4
Return on Investment0.15
Real Return on Investment (Return on investment – inflation rate)0.12
Dividend Yield0.04

What I am trying to do with those assumptions is to calculate the total amount of money you can invest annually and calculate the cash flow (from dividend) per month at age 40.

Monthly Income (In real term)19,00024,068.6327,902.1432,356.23
Monthly Expense7,6009,627.4511,160.8612,938.49
Monthly Investment Capital11,40014,441.1816,741.2819,407.74
Annual Investment Capital136,800173,294.15200,895.41232,892.84
Future Value at age 40 [Annual Investment Capital * (1+real return on investment)^year]1,051,987.32538,225.32354,046.36232,892.84
Sum of all future values14,126,310.73
Cash Flow per Month [Sum of Future Value * Dividend Yield / 12]HKD 47,087

The implication from the above calculation is that if you start early at age 22, based on a very low growth on your monthly salary and good control on your expense ratio, you will be fairly comfortable at the age of 40 since you will have around HKD 47,000 extra income (all calculations are done in real term, i.e. adjusted for inflation).

Of course, you can always challenge the assumptions. I can think of the following:

  • Low salary growth. Yes, I have put a rather low starting salary and low growth rate. For some University graduates, they achieve the monthly salary number at age 40 right from the start. But, this will only make the final cash flow per month bigger.
  • Expense ratio is too low and not constant. Yes. In the later stage in life, we have more expenses, such as mortgages, kids, etc. But I will keep it at 40% to 50% since I think if those expenses exceeded that percentage, you will start to feel quite stressful. But yes, you can adjust the expense ratio to a higher percentage to see the impact. For example, if the expense ratio is 70%, the cash flow per month at age 40 will be HKD 29,710.
  • Return on investment is too high. The multiple decades compounded return of S&P500 is around 10%. That is the baseline which means brainless approach. In my opinion, achieving a 15% annual return is completely doable in the stock market. Of course, you can put in your own assumptions.
  • Cash flow is calculated based on dividend yield only. Yes. Cash flow can come from dividends and liquidating part of your portfolio. If you pay attention, by the age of 40, you will have roughly 14 million of assets in your pocket. If you need some cash, you can definitely liquidate some stocks. But, similar to the salary problem, this will only make the cash flow per month bigger.

The main takeaways are the methodology to calculate your financial status based on a limited set of assumptions. Also, imagine if you not invest, you would have lost a great amount of cash and wealth. Finally, investment using your paycheck will not make you rich using this brainless approach since your starting capital is too small and the growth rate is too low.

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