Retirement planning has two goals. Have the assets to live as you wish after retirement and sleep well in the mean time.
The sleep well part may be the harder of the two. There are reasons. All of them manageable.
Retirement planning is about turning little bits of money into a big pile of money and then turning the big pile back into little bits. The problems that arise involve knowledge and discipline.
How much will I spend once I am retired? Start with how much you spend now on lifestyle. Ignore debt payments, savings, pension, taxes and the like. Probably less than 50% of income. Delete the child costs. Add recreation and travel costs. How much would taxes be today to yield that spendable amount? Result is probable income need. You can adjust as you move along. Don’t assume that what you spend at 90 will be the same as you do at 65. It will not be that much. Depreciating ability. Inflation is less of a deal than many think.
What spontaneous income will there be to deal with that? Pension plans and government plans. You only need to create assets to deal with the shortfall. For some retired people inflation works in their favour. Their personal inflation rate may be lower than the rate implicit in the pension or government plan.
What about inflation? There are a few ways to deal with that. An easy one is use an investment return assumption that is net of inflation. Test to see if 8% interest with 6% inflation is materially different from 4% interest and 2% inflation.It is not as different as you might think pretax. For tax deferred plans, it may not matter at all.
Taxes matter both before and after retirement. be sensitive to containers that have positive tax effects for you. Work it through. Intuition is a poor guide.
A fixed amount of savings is usually too onerous in the early years. Find what percentage of income must be set aside to reach your goal. Sometimes debt reduction matters more and you can use the saving in payments later to catch up.
The rest is just a complicated arithmetic question.
Part I. What is the amount I need at some future time to provide me with the spending that I have determined is appropriate beginning at that time? Plus a margin for error.
Part II. Given the capital sum from Part I, what is the monthly amount I must invest to achieve it? Debt reduction is risk free savings at a good rate, assuming you do not reported.
Wisdom follows knowledge.
You need to know about yourself. Will you save what you need and avoid pulling it out for some other purpose. It is a long time.
How much variability can you tolerate while still sleeping as you wish? You can sometimes feel better knowing that historically, the stock market provides stable returns over long periods. The rate of return on 25 year investments is not constant, but it is closer than most people think.
How does the investment world work and how do you manage the vagaries found there? If you don’t know how it works, every set back will be a source of stress. No sleep. If you do know how it works, you can takes steps to minimize the variability.
Define the signposts. Compound growth is not very intuitive. Having $1,000,000 in 25 years does not imply that you will have $120,000 at the end of year 3. The key is yield and time. The last double provides as much income as all the doubles prior. Most people wreck retirement accumulation plans because they have unrealistic expectation of what the short term should look like. Be certain that you know.
Pay attention to how you are doing compared to your goals. Stock market indices can be a trap. It does not really matter much how the market is doing if you are achieving what you need to achieve.
Regular reviews give you the opportunity to adjust your goals and your savings. The control element. You can change your mind if you want. Reviews tend to keep you on track.
Time heals many plans. As you learn more you can adjust and have a successful life.
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Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: email@example.com