Originally Posted by Henry17
That isn't much of an argument. I'm too lazy to bother uploading excel spreadsheets so we can just use a online savings calculator.
Initial Investment = $0
Amount per Deposit = $4613.12 the amount that someone would pay in 2012
Deposits Increase Annually by = 2.7%
Number of Years = 40
Annual rate of return = 6% (10% generously discounted to account for income tax)
The answer the online calculator gives me is actually slightly higher than what my excel worksheet gave me at $1,094,000.
So what exactly is wrong with my math?
Fergastra, no you're fine. Where are you staying in Canada?
Here is a simple answer:
Pre vs Post Tax Contributions
Your CPP contributions would received a tax credit, whereas your FIY contributions would be net of tax (approx 79% of $4.6k)
Unreasonable Rate of Return
You have assumed a 10% gross pre-tax return, 2.7% inflation, and a 7.3% real pre-tax return (net of inflation).
In contrast, the CPP board is assuming a 4% real return, and that assumption has been criticized as too high in light of recent economic events.
It is pure hubris for you to suggest that you can generate a 7.3% real return for the next 40 years. To be able to do so would earn you a 7 figure salary on wall street.
Similarly, it is an apples to oranges comparison to use a 7.3% real return for your DIY projections, and a 4% real return for the CPP. Consider if you tilted the scales the other way, and used a 0.7% return for your DIY projection.
Taxation of non-Registered Returns
If you undertook a fair apples to apples comparison, you would use a 6.7% gross return (including your 2.7% inflation assumption). You then pay 35% capital gains tax on your 6.7% (a simple example, before we get into tax planning). Your net gross return is 65%x6.7%=4.4%. Your real return is then 1.7% (ie net of 2.7% inflation). Do you see how the tax consideration can decimate your real return? In fairness, there are options to mitigate this, but I trust you see the point.
Best Estimate vs Guaranteed Rate of Return
Your assumption of 10% is not only your "best estimate" but it considers no other possibility. In effect, it is not only high at 10% but it is guaranteed in your scenario. This makes it even more unreasonable.
Consider two options.
Option A pays you $500k in 40yrs guaranteed.
Option B pays you $1m or $0 in 40 yrs w equal likelihood.
Both have the same best estimate of $500k. But the latter includes risk with no premium, and so any rational investor will always choose the former.
A part of what the CPP offers is a certainty of benefit (a guarantee). Whereas in your comparisons, you compare your best estimate calculations with the CPP guarantees. (note that the CPP "guarantees" may not be a true contractual guarantee, but in practice the benefit is the same). This is an apples to oranges comparison, which doesn't properly value the guarantee element of the CPP benefit.
These are just my points on the DIY calculation you put up. We haven't discussed your valuation of the CPP benefit/costs. Nonetheless, I trust you can see that you are missing some of the relevant considerations in your analysis. I would suggest that you (and any other reader) read some books on the matter, go to some proper finance forums, and begin to educate yourself on this stuff. If you are smart enough to win at poker, you are smart enough to understand this stuff.