Ep 6 Advanced: Norm and Norma Invest in Stocks to Achieve Financial Independence
Advanced Real Estate Financial Planner™ Podcast
Welcome to the Advanced Real Estate Financial Planner™ Podcast. I am your host, James Orr. This is the advanced analysis of Episode 6.
In Episode 6, Norm and Norma consider the common investing strategy of saving a good percentage of their income… $1,000 of the $6,000 per month they earn combined and invest that in the stock market to achieve financial independence so they can retire early.
In the simple analysis we used fixed assumptions for property price appreciation, rent appreciation, stock market rate of return, inflation rate and mortgage interest rates.
For the advanced analysis we’re going to see how getting random returns in the stock market and inflation will impact their ability to achieve financial independence.
Before we get to that though, I do want to make a few comments to narrow down and simplify what we will discuss here in this advanced episode.
Since Norm and Norma aren’t buying any properties in this episode, there isn’t a need to discuss all the real estate related metrics we might cover in future episodes.
It doesn’t matter if property appreciation rates are variable. They don’t own any properties at any time. So, rent appreciation doesn’t matter either for the same reason. And, neither does mortgage interest rate.
So, really, they’re primarily impacted by the stock market rate of return being variable and the inflation rate being variable.
Stock Market Rate of Return
For the stock market, in the simple modeling we assumed they were earning a static 8% per year on any money they had.
For the advanced modeling, we assume that it changes each month. It varies between an annualized rate of return of -16% and +32% in steps of .1. The standard deviation from mean is 8 points.
If we take 5,000 test data points, the distribution might look like the chart below with an average of about 8% per year… which is similar to when we did our simple modeling.
If the stock market does better, they are more likely to achieve financial independence sooner. This tends to have a bigger impact as time goes on because… in general… they have more invested in the stock market later and so a good return in the stock market has a bigger impact on them if they have more money invested in the stock market.
For example, if they only have $10,000 invested in the stock market and the market goes up 20% in that year, they have about $2,000 more or about $12,000 total at the end of the year. But if they had $1,000,000 and the market went up 20%, they’d have $200,000 more… or about $1.2 million total at the end of that year.
It works the other way too… if they have a down year in the stock market, it impacts them more… in sheer number of dollars… the more they have invested in the market.
Inflation
For inflation, it can be a random rate between -3% and positive 9% in steps of .1. The standard deviation from the mean is 2 points.
If we took 5,000 samples, the average would be around 3%… which is what we used in the simple modeling.
The inflation rate impacts how much Norm and Norma make with raises. The get raises that keep pace with inflation.
Also, the inflation rate increases their personal expenses. So, their personal expenses go up over time.
That also means that their financial independence goal is also going up with inflation. As time passes, they need to have their investments generate a higher target amount to be considered financial independent.
If inflation stays low, the income from their job does not go up as quickly but neither does the target amount they need to be financially independent.
If inflation is higher, they get larger raises with their job and higher personal expenses but the target amount they need to have invested to be considered financially independent is also higher.
A higher inflation rate essentially erodes how effective the amount they’ve already saved is toward achieving financial independence.
In other words, if they have $1,000,000 saved and invested in the stock market… but inflation increases by 10% over the course of two years, it is as if they lost 10% of the value of the million dollars in the stock market. Of course, some of this is offset by the return they receive by having it invested in the stock market.
Really, what they should be concerned with is the net difference between the inflation rate and the stock market rate of return.
If the stock market return was 10% for the year, but inflation was 3%… they really netted 7% return overall.
Since our modeling does have random inflation and random stock market rates of return it gives us an idea of what the range of outcomes might be for Norm and Norma in a variety of combinations of inflation and stock market returns.
Financial Independence
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