Equation for how much would you have to have in the bank....
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Financial Planning - Financial planning in general. (Moderated) 

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Equation for how much would you have to have in the bank.... Samson 08-02-2007
Posted by joeu2004 on August 2, 2007, 2:14 pm
> A question about compensation for elected officials has come
> up in a local community forum. One of the ways that the city
> council members are compensated is with life time health
> benefits if they serve six (probably consecutive) years. How
> does one go about calculating that?
>
> Let's say that there is at least one known factor: The health
> insurance policy goes for about $300 a month for a member
> who is 50 years old.

It is the net present value (NPV) of the expected cash flows. Of
course, all of that depends on a number of uncertain variables.

Suppose that you expect the council member to live for 40 years (based
on actuarial tables), you expect health insurance costs to rise 7%
annually (based on financial planning inputs), and you fund this
annuity with an investment that you expect to increase at an average
rate of 5% annually. Then in Excel terms, the required initial
investment could be estimated with the following array formula (commit
with ctrl-shift-Enter):

=roundup( sum( (12*300)*(1+7%)^(ROW(A1:A40)-1) /
(1+5%)^(ROW(A1:A40)-1) ), -3)

ROW(A1:A40) simply generates the numerical sequence 1,2,...,40.

That formula assumes an annual annuity. It could be modified to
account for a monthly annuity. But that's a nitpick; after all, this
is just an approximation full much larger inaccuracies anyway.

The actual required initial investment should be determined using a
stochastic model that attempts to account for the varying health
insurance inflation rate and, probably more significantly, the varying
investment return rate over 40 years within a high level of confidence
(e.g. 99.7%). There are probably professional-grade (read:
expensive!) tools out there to do this kind of computation.

But if this is just an ideal curiosity, the formula above might
suffice.


Posted by Samson on August 3, 2007, 5:05 am
Thanks for the great answers - both the rule of 25 and the in depth
excel formula. (My brother-in-law is coming over this weekend can
help me with that and give me a good lesson in excel.)

I raised the question because I am commenting in a local community
forum discussing how much the city council members are being paid.
The idea that we could ever change this is almost as unrealistic as
thinking that congress will ever have the politcal will to fix the
social security or that the California legislature can fix their
problems.

Many government pensions are grossly out of wack with the private
sector and are going to be an unbearable burden for all us taxpayers
soon. Any tools that can show it to the voters might be helpful.

Thanks.


Posted by PeterL on August 6, 2007, 11:30 am
> Thanks for the great answers - both the rule of 25 and the in depth
> excel formula. (My brother-in-law is coming over this weekend can
> help me with that and give me a good lesson in excel.)
>
> I raised the question because I am commenting in a local community
> forum discussing how much the city council members are being paid.
> The idea that we could ever change this is almost as unrealistic as
> thinking that congress will ever have the politcal will to fix the
> social security or that the California legislature can fix their
> problems.
>
> Many government pensions are grossly out of wack with the private
> sector and are going to be an unbearable burden for all us taxpayers
> soon. Any tools that can show it to the voters might be helpful.
>
> Thanks.

If you want to have an impact on the audience in your community forum,
stay far far away from any Excel spreadsheets. Nothing turns an
audience off faster than math formulas.


Posted by joeu2004 on August 6, 2007, 12:04 pm
> If you want to have an impact on the audience in your community forum,
> stay far far away from any Excel spreadsheets. Nothing turns an
> audience off faster than math formulas.

Knowing how to do calculation so that you can present credible numbers
and "showing your work" are two different things. In Calif, the
Legislative Analyst always explains the financial impact of a bond
initiative, and you can bet that he/she uses the correct mathematical
formulas and models to do so (or professional software that relies on
them). But of course, the LA simply reports the conclusions, not the
math behind them. That is how I interpreted the OP's intentions.

Also, knowing how to do the calculation allows us to validate (or to
see the flaws and over-simplifications in) the seemingly inexplicable
"rules" that pundits regurgitate, often ignorant themselves of the
basis and ass-u-me-tions behind the "rules".


Posted by Will Trice on August 6, 2007, 12:06 pm


PeterL wrote:

> Nothing turns an
> audience off faster than math formulas.
>

In a thread that asks for an equation?

-Will


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