Are my calculations correct?

musehead

I'm a 21 year old (soon to be 22!) who has been thinking about putting money into a pension recently. I've been considering opening a SIPP with H-L, which would be convenient as it's in the same place as my ISA and i'd like to have control over my investments. I don't have a job at present and am unlikely to for the next couple of years, but I do have enough spare cash to start a pension going. As I understand it, I put in £2808 each tax year which is topped up to £3600 by the government. I've been using the compounding calculator here:

http://www.fool.co.uk/school/compound.htm

I've been inputting £300 per month into the calculator, but in reality it will be £3600 per year as a lump sum - i'm not sure if this affects the end result much. If I put in £2808 for the next 10 years (£3600 after tax relief) for a total amount in of £28080 (£36000), and then let it compound until i'm 55, a further 24 years, assuming a 10% annual rate of return I should end up with £595,288. If I do the same but with a 15% rate of return I should end up with £2,258,670.

Firstly, are these calculations correct?

Secondly, are these rates of return realistic? If I put the majority of my SIPP money into UK Equity Income funds for instance, with some in lower risk funds and a small amount in higher risk or speculative funds. I feel it should be OK to go down a high/very high risk route since there are a minimum of 34 years before I can touch the money. Would I be expecting sub-10% returns, or would 15% be achievable?

Thanks for your help!

CLAPTON

I dont know about your maths but work it out net of inflation.

If inflation over the next 40 years is similar to the last 40 years your 600,000 will have the purchasing power of about 30,000 in todays money.

The government will sell you a 40 inflation linked gilt with a coupon of about 1.5%.

ffacoffipawb

CLAPTON wrote: »

I dont know about your maths but work it out net of inflation.

If inflation over the next 40 years is similar to the last 40 years your 600,000 will have the purchasing power of about 30,000 in todays money.

The government will sell you a 40 inflation linked gilt with a coupon of about 1.5%.

Yes I agree.

Try using a 2% (real) interest rate to grow your fund.

Then divide the result by 20 to give an idea of the annual income that the fund will give you (in today's money).

Could you live on that?

musehead

Thanks, I wasn't sure what to do about inflation.

Surely I would be able to do better than inflation + 2% though? I can almost get that in a savings account, index linked certificates etc.

CLAPTON

Don't take my figures at face value as I was wanting to make the point that its very important to take inflation into account if you're thinking long term.

I'm sure you can find some figures for stock excange growth and inflation over the last 30/40 years to give you some ideas.

You may be dismissve of a 40 year average of inflation plus 2% but over much of the last 40 years savings actually had negative real interest rate.

However, its an excellent idea to start some long term saving/investment especially if the tax man's helping you.

Also be vey cautious about the view that says 'high risk' equals 'high gain' as it also means that some people will lose lots (thats why its high risk).

EdInvestor

musehead wrote: »

Thanks, I wasn't sure what to do about inflation.

Surely I would be able to do better than inflation + 2% though? I can almost get that in a savings account, index linked certificates etc.

Long term returns are based on economic growth plus inflation plus the market dividend yield, so maybe around 10%.

But you have to deduct charges, both explicit and implicit, so that will usually bring it back to around 7% unless you invest in shares directly.

musehead

So that's an assumed long term return of 7%, but I need to take away inflation from that to compare my final sum to todays money?