Arggh, Compound interest.
Everyone throws this phrase around and we need to get some clarification around it. I mean even Kimmy Schmidt claimed to get it and she was spot on with her math but way off with the logic of applying to real world scenarios. (If you have no idea who Kimmy is check it out on Netflix show) Let’s take her exact example. So Jane Krakowski’s character Jaqueline thinks that she can’t afford to divorce her husband because due to a prenup she will only get $1,000,000 for each year of marriage, totaling $12,000,000. Kimmy sets out to prove that this is, indeed enough money for Jaqueline to maintain her $1,200,000 a year lifestyle. Jaqueline starts the conversation by saying it would only last her 10 years.
12,000,000 / 1,200,000 = 10. That’s how she got her answer.
OK so if finance were that easy, you would be rich. So rest assured, it’s not. And you still can be rich.
Then Kimmy complicates everything by saying something like “I love beanie baby’s and you forgot about compound interest.” She makes a grand proclamation that Jaqueline can get 7% rate of return every year for the rest of her life. If she did, she would have $5,865,000 at the end of 10 years and could probably struggle through.
But that’s not the whole story. All of of this money is growing with tax implications. Which means that the government is taking part of that cash money. Here is what the numbers look like once we take into account a 20% capital gains tax rate. (That means that all investments stayed invested for over a year.)
Now, for those of you who can deal with numbers, take a look at it with taxes:
Can you spot the difference?? Yeah the $1,173,099 in the red category called “Annual Income Tax.” To put in normal language that means that this chick would have to come up with almost $1.2 million dollars extra to pay taxes while she spends her $12,000,000 down. If she took it out of the account we are looking at, that means instead of the sweet $5.8 million she has pre-taxes, she would only have $4.6 million. Not chump change, I realize, but a big deal if you live on $1,200,000 a year! That’s the impact of taxes on your beautiful compound interest.
But wait, there is more.
Kimmy, who, let’s face it lived in a bunker for a decade, suggests that Jaqueline could get 7% in the stock market. Let’s test her theory by taking a look at the history of the stock market. (Remember this picture?)
So, not guaranteed to get your 7% there. I mean you could it you’re lucky, but certainly not every year for 10 years in a row.
So if not the stock market, may be she could get it in the bond market!
Yeah, no again.
Not sure where she came up with 7% unless that’s a real nerdy 90’s reference cause that’s what people thought they could always get back then. Then in went down to 5% and now the Wall Street Journal claims the only sustainable number is 2%.
So conclusion? Mine is that Kimmy essentially did some old school needs based planning nonsense. Let’s take this out to it’s inevitable conclusion. Is Jaqueline going to keep the same clothing forever? Will she stay in the same house? Will she keep the same phone? The same face? Or will she keep up with the Kardashians and have an ever expanding lifestyle that costs her more each year because that’s what’s most important? Yeah, I think so to! So here is what her money would look like if we assumed that each year her life cost her 3% more then it did the year before. That’s called inflation kids, or the more inclusive term cost of living.
But that’s not it. What about paying for college for her son? What about parent care? (I doubt the reservation has a great nursing home or assisted living facility). What about her own care? How many more staff members? What if she gets sued?? This is all open to creditors. So really with life being life, Kimmys’ assurances are worth about as much as the Reverands. And, let’s be honest, Jaqueline would absolutely want some sort of legacy to be left behind so she will never be forgotten. May be an endowment? A wing of a museum or hospital? A scholarship program? Where is the money for that? Not in any plan here. So needless to say Kimmy’s plan is far from complete.
And that, my friends, is why you should never take your financial advice from sitcom characters.