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As structural imbalances in the economy worsen, it is the middle class and poor that will increasingly become burdened with a lower standard of living but this needn't be the case. Nayem Kabir lays down a challenge to change your thinking when considering the potential to retire young & retire wealthy.

The Economy is Broken

Over the last few years I've lamented the belief that the structural problems facing the US and UK remain unsolved and will ultimately lead to higher interest rates and soaring inflation. While the power of central banks and their appetite for monetary easing has meant interest rates remain at record lows (thanks to near unlimited power to buy treasuries and keep long term yields down), the economy itself still seems to be in the hollows with the impact being felt the most by the average man in the street.

Politicians on both sides of the Atlantic have been quick to cite an improving jobs market but the reality is that as of March 2012, US Labor Statistics showed that unemployment stood at 8.2%. Things aren't much brighter over in the UK where the most recent data shows official unemployment at 8.3% and 1 in 5 people aged between 21 and 24 don't have a job. In an interview with the BBC, Liam Byrne, the shadow work and pensions secretary, expressed his concern over those who have been unemployed for at least a year: "The number of people long-term unemployed is now up about 50% on the year."

A report this month by PayScale in the US showed wage growth in the US is currently at a 3 year high and the trend over the last 4 quarters is up but this fails to take into consideration inflation which is rising at a faster pace. The Huffington Post ran an interesting piece only last year showing that data indicates the US has seen no real income growth since the 1970s.

All in all, we have an environment where unemployment remains stubbornly high despite Central Banks throwing everything but the kitchen sink at it & those with jobs are struggling to keep up with the general rise in prices each year.

Perversely while the working & middle classes struggle, investors have done pretty well in the last year with the Nasdaq share index up 8.5% as corporate profits continue to soar.

A Challenge To The 99%

In a recent discussion with a group of 20 year olds on a train to London, I posited the view that it is entirely possible for someone working aged 20 to not only retire at the age of 40 but do so having the same income that the average person currently working full-time earns. Upon hearing this, the group gasped in disbelief and one person cockily quipped "only if you're already rich."

A deep fallacy that breeds resentment among some members of the general public is that rich people are rich because their wealth provides them with an unfair advantage. Forbes published an article citing Occupy Wall Street Protests last year against "income inequality and the burden of action." While the growing income disparity is very real I do not subscribe to the view that the sole cause is driven by 'the rich'. Indeed, in most cases, the wealthy are rich because they demonstrate a sharpness, tenacity & perspective that the average person typically chooses to neglect. Steve Jobs is a classic example of what can be achieved from humble beginnings providing you have the right mind-set.

According to the ONS, last year the median salary for a full-time worker in the UK rose 1.4% to £26,244. Census data shows the US median per capita income is broadly the same at $27,000. This is roughly $23,000 after income taxes. Assuming $10,000 a year living expenses & a person is left with $10,000 disposable income.

The personal challenge is to therefore see if $10,000 a year can be turned into a pot that generates $20,000 a year in passive income over a 20 year period. In theory this would allow a 20 year old to retire at the age of 40 and earn the same nominal amount as the average person working full-time. Wouldn't it be great to retire at 40 and earn the same as you do now? Alas a lofty but achievable goal if you're willing to change your mind-set.

The Power Of Mathematics & Compound Interest

Albert Einstein allegedly called Compound Interest the greatest mathematical discovery of all time. The concept is simple yet so effective. It essentially involves the continuous re-investment of returns so that the principle investment grows at an exponential rate. Too much gobbledegook? Fear not, let's use an example to illustrate the point. Say you have 1 cent & you double it to 2c & then again to 4c. How many times would you have to double the original cent to get 100,000,000 cents ($1m)? .....Indulge yourself & take a few guesses. Most people I ask guess wildly in the range of 1,000 to 50,000 times. The actual answer is a mere 30 times. Using the theory of compound interest it's possible to double a cent 30 times & come up with $1m.

My investment of choice to compound returns is high growth dividend stocks.

The Theory

All things being equal, a $10,000 investment with a current yield of 8% that grows at 4% annually would generate dividends of $13,000 a year after 20 years of reinvesting dividends into more shares. Assuming the process is repeated with an additional $10,000 in a new investment the following year, compounded over 19 years the investment would generate $11,266 in dividends each year.

With just 2 years of capital, the total annualised dividend income would be a staggering $24,833 annually after 20 years of compounding. If one were to continue this process with a new investment every year for 10 years, the annual passive income available to the individual after retirement would be in the six-figure territory.

Dividend Opportunities

A whole number of opportunities exist but in the meantime here are 3 star dividend payers the savvy income investor should consider which take into consideration:

  • The current yield (how much I'll get paid starting from year 1)
  • Average annual dividend growth over the last 11 years (how much my income could grow each year)
  • Share price return over the last 5 years (I want to ensure my capital will be safe - even during a one of the worst recessions since world war II)
  • What my annual dividend income would be assuming $10,000 invested in each company with the average dividend growth rate being maintained & reinvestment of dividends to compound my returns over 20 years

Company (ticker)

Dividend Yield

Ave Div Growth

5yr Shareprice

Annual Income in 20yrs

Johnson & Johnson (JNJ)

3.76%

12%

1%

$29,300

Procter & Gamble (PG)

3.49%

11%

2%

$16,355

Abbot Laboratories (ABT)

3.29%

9%

9%

$7,181

Total Annual Dividend income

$52,836

Don't let the comforts of today mask the need to prepare for the urgency of tomorrow. This live challenge will show how it's possible for the average man on the street to retire rich and retire young.

Nayem Kabir is a London based investor with an interest in macroeconomics and deep value plays.

To stay tuned with the portfolio launch, detailed analysis & updates please subscribe for alerts. You can also get in touch directly & follow on Twitter: @nayemkabir

Source: Retire Young And Retire Wealthy: An Open Challenge For The 99%

Additional disclosure: Disclaimer: This article does not seek to provide financial advice & you should consult a specialist before transacting in securities or any particular investment strategy. Past performance is no guarantee of the future.