I want to explain how people should look at calculations like the one Maverick got from Sanlam, because it is designed to trick people who suffer from money illusion. From Wikikpedia: "In economics, money illusion, or price illusion, refers to the tendency of people to think of currency in nominal, rather than real, terms."
The illustration is shown in nominal terms, but it makes some weird assumptions which would be more appropriate for an illustration in real terms, and therefore most people see the end values in 2014 Rands, when they actually represent 2046 Rands.
To get the correct perspective one should assume an inflation rate to translate these numbers into real terms. 6% would be a reasonable assumption as this is the future inflation rate the market expects right now.
The 10% annual premium increase therefore represents a 4% real increase. This premium will represent a larger proportion of your income every year, unless you get a pay increase of more than 4% above inflation every year. This is not realistic, our economy struggles to grow at more than 3% above inflation, so the average pay increase cannot be more than economic growth can sustain. 3% is the max, many people will struggle to sustain pay increases much above inflation, so a premium growing at 4% above inflation will become a substantial burden over time.
The 10% return assumed actually represents a 4% real return after 6% inflation. (It is actually 3.8% because the nominal return is the product of inflation and real return.) This is a fairly reasonable assumption for expected real returns from a balanced portfolio.
So the 6% inflation earned means nothing to an investor. No one would invest if you only kept pace with inflation – rather spend it, less risky. The 4% real return is what you actually get so if Sanlam appropriates 2.3% of it for themselves, that represents 58% of the return which the market feels you deserve to get for the risk you take, leaving you with a paltry 42% of the real return. If they take 5% it means they are taking more than the real return you can realistically earn – you are better off spending your hard earned money now because it will be worth less to you when you spend it in retirement.
So adjusting Sanlam’s numbers for inflation we get:
R1,207,000 premiums minus inflation = R376,000
If it grows at 10% nominal (4% real): R3,851,000 = R660,000 after inflation (in 2014 Rand terms)
If it grows at 7.7% nominal (1.7% real after costs of 2.3%) :R2,798,000 = R471,000 after infl.
If it grows at 5% nominal (-1% real after costs of 5%) :R2,005,000 = R332,000 after infl.
