In a previous post I wrote about what I could expect as the long term return of the market, which I found to be 7.5% per annum. In this post I will discuss what this implies for my portfolio return, and highlight some of the other variables that may alter the terminal value of my portfolio.
The expected returns of my portfolio are calculated using a simple model that consists of only four variables. But changes to any of these could alter the terminal value tremendously. Let's go trough them quickly:
Number of years
The holding period of the portfolio will have a significant impact on the end value, mostly due to the effect of compounding interest. As an illustration I've put 20 years as the initial value here.
Value at year zero
This is a quite easy variable to set. Just input your capital base at the moment. I have $36,000 at this time of writing.
Now here comes the tough part. This variable will greatly influence the terminal value of any investment, and the expected annual return is highly debated. Some investors believe they can outperform the market return on a continuously basis, but I've settled for just following the market, and therefor stated an annual rate of return of 7.5%.
The annual return consist of both dividend income and capital gains. I have a taste for dividend income, and will try to keep this around 5%, the remaining 2.5%, equal the target inflation rate in Norway, is expected to arrive from capital gains. The high dividend yield enables me to re-invest at a higher rate, and the effect of compounding interest will help me accelerate the growth of my portfolio.
This is yet another variable that have a strong impact on the terminal value of my portfolio. As you will see from the table below, most of the new investment will come from annual savings the first years of the portfolio. It is vital that I keep this figure as high as possible to keep investing the years to come, and take advantage of the effect of compounding interest.
I've set $10,000 as the initial value here. This is close to my current savings rate, which I will try to keep up in the foreseeing future.
Now having declared all the exogenous variables, we can input those in the model and calculate the final value of my portfolio. Note that you can update the figures yourself and see the effect.
The chart above clearly illustrates the effect of compounding interest. Over a time period of 20 years I end up with $585,969 by the power of compounding interest. And if I'm able to increase my savings to $20,000 per annum, my portfolio will reach 7 digits in 20 years.
With these findings I have established two key goals for my portfolio:
- Keep the investment horizon above 20 years
- Increase my annual savings rate, preferably around $20,000
|N||Start value||Capital gains||Dividends||Savings||Value at end|