ISA Calculation

Browntrout_2

ThankYouAndEnjoy! wrote: »

Hello

Could someone please tell me how much 41 years of Cash ISA investments would be worth please. Assuming the following

£3000 per year, each year, transferred in on new tax year date
5.8% interest per annum

I have a figure, not sure if it correct tho! (used excel) - are/is there a calculator out there that would work this out for me??

Thank you

On my HP 12C Calculator

• 5.8% = £497,469.38
• 7.0% = £688,896.72
• 10% = £1,609,910.98
• 15% = £7,061,990.80
• 20% = £31,729,065.87

cheerfulcat

ThankYouAndEnjoy! wrote: »

Assuming this trend of Interest and inflation rates remain constant over the next 41 years, then surely i have made a gain on my Captial Investment??

Only if the capital sum you put in every year rises with inflation as well. The £3000 you contribute this year is worth considerably more than the £3000 you contribute in 10 years' time. The ISA limits really ought to be index-linked...

Am i looking at this too simplistically?

'Fraid so. The point is that inflation will eat away at the value of your capital, whether it has gone up in nominal terms or not.

masonic

ThankYouAndEnjoy! wrote: »

Am i looking at this too simplistically? -

Yes, as CC says, you still haven't taken into account the effect inflation has on the amount you are putting in.

You have made a gain in your capital investment, it's just that your capital investment itself is being eroded by inflation each year because you are not increasing it in line with inflation (it is always £3000).

In terms of value in the future: Paid in £123k, Balance £497k
In terms of todays money: Paid in £57k, Balance £75k

What you are doing is considering inflation on your final balance, but not considering it for the money in your pocket. Inflation means next year £3000 will be worth less than it is now. If inflation is 4.5%, it would only buy as much as £2865 would buy now. You can consider it like an exchange rate going down so that your "future pounds" will be worth less and less in current money the further forward in time you go, so to do your calculation based on todays money, you need to convert those "future pounds" into todays £ before you add it on to your investment. So that means adding only £2865 in year 2, £2736 in year 3...etc.

ThankYouAndEnjoy!

masonic wrote: »

In terms of value in the future: Paid in £123k, Balance £497k
In terms of todays money: Paid in £57k, Balance £75k

Hello

Thankyou. It wasnt until you posted this figure that i am now beginning to understand your figures.

On a slightly off subject. When people say 'you can save money at above your mortgage APR so will be better off year on year' are they giving incorrect information?

Eg

Current Savings - 6.00% Tax Free
Mortgage APR - 5.9%

After Inflation, would the true value of the savings actually be less than the mortgage APR, meaning it would be more cost effective to make o/payments onto the mortgage??

masonic

ThankYouAndEnjoy! wrote: »

After Inflation, would the true value of the savings actually be less than the mortgage APR, meaning it would be more cost effective to make o/payments onto the mortgage??

No, because, in real terms, while inflation will be shrinking the size of your savings it will also be shrinking the size of your mortgage debt at the same rate! Obviously the money that is going in is the same in either case, so in fact inflation makes no difference in this example.

ThankYouAndEnjoy!

Super!!

Thanks for all your help

Slim

I thought I understood this but now I'm not too sure.
If, as in the figures quoted here, annual net interest added is greater than annual inflation then the lump sum must increase in real terms. How can it reduce?

Sam_84

Brasso asked what a steady annual amount invested in say a FTSE tracker over the past 41 years would amount to now.

(Sorry this is a bit long, but as I was writing, there were more things that came to mind - oops)

Before we get into the returns on investing in shares, others have pointed out how important it is to ensure that you earn more on your investment than it loses through the corrosive effect of inflation. So, it's worth introducing the phrase 'real returns'. This is the jargon phrase that simply means returns after allowing for inflation. So, for example, if you had a cash ISA paying 6% and inflation was 3.5%, then the real return would be 2.5% (note 1). And you are overall better off - really! (Sorry for the bad pun).

(I'm not going to go into what the right rate of inflation is - it's pretty obvious that pensioners have suffered from a higher rate of inflation than the general population so you might want to factor that into account when you see the numbers presented in the newspapers.)

Achieving positive real returns is the key. We have had periods of negative real returns in the past - great if you're overall in debt but lousy if you are on a fixed income. In calendar 2006, people invested in gilts suffered negative real returns.

A great source for comparing long-term returns is the Barclays Equity-Gilt Study. A summary of the 2007 edition is online at https://www.equitygiltstudy.com. I don’t have the latest printed edition but I do have last year’s (to 31.12.2005).

Extract from quote on Barclays’ website:
Broadly, equities strongly outperformed bonds and index-linked securities, which posted negative returns. UK gilts and index-linked markets performed very poorly in 2006 […], while equity returns were far above the long-run average. UK equities returned 11.4% after inflation, against minus 4.4% for gilts, minus 2.1% for index-linked and 0.4% from cash.
(source: https://www.equitygiltstudy.com)

So, back to the long term investment in shares question:

In the OP's post, he is leaving the interest in his ISA each year so he gets interest on interest. So, we'll assume that the dividends earned on the shares are used to buy more shares so we're comparing like with like as best we can.

These figures assume no income tax and no capital gains tax.

I used the table of values in the Barclays Equity-Gilt Study, table 76, column 1 and an Excel spreadsheet to work out the value of investing equal amounts of £3,000 per year each year from December 1964 to December 2005. I haven’t allowed for inflation.

Total amount invested £123k, value at end of period £4.9 million.

VERY IMPORTANT - Remember this is historically what happened 1964-2005 and bears no relation what will happen in the future. That time in history contained some very interesting periods with huge equity returns and no-one can say if they might be repeated.

If you have a look at the full 2006 study (note 3), you can do all sorts of interesting comparisons of returns over periods. For example, for those of a nervous disposition, they might not want to look at the large swings from year to year between positive and negative returns from equities. Alternatively, the table that shows the likelihood of equities giving a better return than cash over various periods ...

Hope this helps and apologies for the length of the post.

Cheers

Sam


Note 1 - Yes, you should really calculate 1.06/1.035 giving a real return of 2.42% but it's close enough given that we won't know what inflation will be until it's too late <smile>

Note 2 – As the FTSE-100 hasn't been around for 41 years, Barclays use the FTSE All-Share instead (for periods from 1962).

Note 3 - This is a link to a pdf of the 2006 edition of the equity gilt study:
http://qa.hedgeweek.com/download/2071/Barcap%20Equity%20Guilt%20Study%202006.pdf

Note 4 – This is a link to an extract from the 2007 equity gilt study
http://www.personal.barclays.co.uk/PFS/A/Content/Files/CHAPTER_1_Equity_Gilt_Study_2007_07Feb07_inc_cover.pdf

masonic

Slim wrote: »

I thought I understood this but now I'm not too sure.
If, as in the figures quoted here, annual net interest added is greater than annual inflation then the lump sum must increase in real terms. How can it reduce?

It does increase in real terms. The confusion you are experiencing comes from the fact that it can be expressed either in terms of its value in the currency at the end of the 41 years, or in todays money. In post #14 I've compared to two different ways of looking at the situation. You'll notice in both, the final value is greater than the value of the deposits made. The confusion comes if you look at the final value of the investment in 'todays money' and compare that with the total sum invested in absolute terms. Either, you look at it as paying in £57k in todays money and getting back £75k, or paying in £123k in total and getting back £497k. You can't mix and match.

So, to summarise what I've said in previous posts, inflation doesn't just affect the 'real term' value of your investment, it also affects the real term value of your contributions, such that £3000 paid in in future years is not worth as much as £3000 paid in today.

Sam_84

Yup - I agree with masonic. In particular, I hate those forecast letters from the pensions companies which, whilst trying to help explain how much your pension might be worth, really confuse me with their future values, today's terms, assumptions about pension rates, etc., etc. It doesn't help that different companies have different ways of presenting the info.

(head starts spinning and goes for lie down)