Regular Saving, Compounding and Inflation (Retirement) Harvard Case Solution & Analysis

Regular Saving, Compounding and Inflation (Retirement) Case Solution

Compounded Savings

The compounded savings is a best way for planning for the future and make retirement planning earlier. The compounded savings provides benefits of living a better retirement life. To estimate a compound savings, it is assumed that the person will make savings of $12000 yearly form the age 25. It is estimated that the interest earned on that saving will be 4.5%. Thus savings for the first year will be totaled to 12540. The investment amount will then earn more return as the savings gets accumulated with additional principal contribution and interest earn on that principle. In this way the accumulated savings increases year by year and the return on the accumulated savings increases too. At the end of the year 60, the person will be able to accumulate savings of about $1 million. Interest is calculated by multiplying the compounded investment amount at the year-end (that includes previous year investment and interest plus current year investment amount). Accumulated savings is the total savings from the date when investment savings started and includes all savings that has been made till the end of the current year. See excel for all calculations and formulas.

Retirement nested or Retirement plan

The retirement plan is made to analyze the savings, interest compounded and the effect of inflation on the savings. The inflation, personal expenditures, interest rate and investment values are all estimated and incorporated in the plan. The inflation rate is taken as 1.10%, form the internet sources, reference is in Excel. The interest rate or rate of return on investment is assumed to be 6%. It is assumed that the person will make the Initial investment of $1 million that he has saved for retirement. This $1 million has come from the savings that has been accumulated from the previous calculation. Thus the person will invest this savings in a long term fixed deposit account that will earn return of 6%. The annual withdrawal is estimated to be $70,000, as it is assumed that the person will need this amount for living, buying necessities and meeting increased medical expenditures and leisure activities. It is assumed that the person will get retirement at the age of 65. Using all these assumptions and estimates as inputs, the retirement plan is then calculated.

Estimated average annual rate of inflation1.10%
Estimated average annual rate of investment return6.00%
Initial investment value at retirement$   1,000,000
First year of retirement2016
Planned annual withdrawal$       70,000
Age at end of first year of retirement65

Thus at the age 65, the person with the investment of $1 million has been getting return of 6%. The first year withdrawal is $70,000. It is seen that the withdrawals has been increasing and the investment value is depleting year by year. The reason for that is inflation which will be discussed later in the below section. The Social deposit or withdrawal is assumed to be null for simplicity and make the analysis easier. Annual withdrawal percentage is also calculated so that it can be compared and analyze easily with the other elements of the nested retirement plan, especially rate of return that remain same. While looking at the overall plan, the person will have utilized its savings including return on savings at fullest up to the year 2041, where the investment value becomes negative conferring that the investment has been used and the withdrawals cannot be made. At that year the withdrawal amount available is only $40,877, which includes remaining investment amount and that year’s interest on that remaining amount.

Impact of Regular Saving, Compounding and Inflation

Inflation can be defined as a sustained increase in the general prices of goods and services. Thus Inflation significantly affects the savings or retirement investment of an individual. Inflation doesn’t directly affect the savings but indirectly. The impact can be explained that inflation increases the prices of goods, which demands higher purchasing power from the consumers(Morgan, 2016). Thus a product that is available earlier at a specified price will be, after inflation, available at higher price. In general circumstances the purchasing power of consumers gets balanced with the dearness allowance or cost of living allowance from the employer. But when an individual make savings or invest money, for any purpose especially for retirement, the situation is different. The interest that is being earned on the money invested increases the money in lower rate than the rate of increasing prices due to inflation. Thus the person’s purchasing power decreases. As an example, let a person has planned to buy a car worth $1 million. He starts saving the money in a fixed deposit account. Later on when the savings accumulate to $1million, the cost of that car has been increased to $1.2 million due to inflation. Thus, now the person needs more money to buy that car....................

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