People are emotional. Fear gets in the way. So does greed. Frustration is common and very hard to cope with because it is a basket of emotions rather than just one. Anger, fear, embarrassment, self-pity, injustice, envy and discrimination to name a few.
When things turn out adversely people need someone or something to blame. The key to fixing the problem is to notice that they are focused on the outcome. Snapshots don’t convey all the information needed for success.
Complex problems have answers evolving over a long time, so process or systemic thinking is the way to go. Interval outcomes mislead you. People must trust process to achieve long term goals.
Suppose you want to save money for some distant project. Retirement for example. How do you design the process?
Define the goal. Accumulate some amount of money in a given term. If you are 40 and retirement is at age 65 then 25 years to accumulate. But how much?
How much depends on its purpose. It is like buying a computer. You cannot make a good decision until you know what it is for. In this case spending over some number of years. For a couple aged 65 today 25 years is reasonable.
Spending on life style is the key. What will lifestyle be then?
Lifestyle is consumption. How much does consumption cost now? Never mind taxes, pension plan contribution, government plans, mortgages and children costs. They go away, well maybe except taxes and there are ways to manage that. For most people consumption after taxes, debt and other deductions, including children is less than 40% to 45% of gross income.
Some or maybe even a large part will be provided by pension plans and government plans. You must save your way to a solution for the missing part. Suppose for a couple 45% is $6,000 per month and they expect all of the plans available to supply $5,000 of it before taxes when they retire.
If they were retiring now, and assuming the tax rate doesn’t change much $6,000 per month is $36,000 each after taxes and about $41,000 before taxes. So we need $82,000 per year evenly divided. With pensions providing about $60,000 of that.
They need an amount of capital that is enough to provide $22,000 for 25 more years. Just arithmetic from here. We have two series. One of accumulation and one of spending. Their values must be equal.
$22,000 with inflation at 2% will be $33,000 by age 65. So we need to receive $33,000 plus inflation for 25 years. (You won’t need that much, but that is another factor). If we assume an investment yield of inflation plus 3%, the capital at the beginning will be $570,000. That is an outcome and it will generate various emotions.
The process idea is different. How much do you save next month?
$775 or roughly 5.8% of current pretax income. The decision for the container will require some more analysis, but for our purpose retirement plan, or tax free savings account, or debt reduction now for more saving later are details to be optimized. The process says about 5.8% of annual income each year.
Analysis generates soothing thoughts.
- A big number is just the result of a small number for a long time. Retirement planning is the process of turning small amounts monthly into a large pile of capital and then turning the large pile into small monthly amounts. Nothing hard about that.
- The method is a variable and you can analyze it for most efficient results.
- The investment process depends on long term relationships between inflation and yield. Plus 3% pretax is not a stretch goal. Plus 4% would drop the monthly requirement to $600.
Your only current input is the required saving. Everything else is outside your immediate control. You trust the long term investment process.
- You have a balance between present lifestyle spending and future lifestyle spending. It is wrong to impoverish either.
- If circumstances change, you can analytically address its effects. Questions like, “I want to retire at 63 instead, how much must I reduce lifestyle.” About 8%
- “If I change lifespan to 20 years from retirement how much do I save next month at inflation plus 3%?” $660.
Processes can change. So the answer is not ground into a granite rock on day 1. If you get a raise of more than inflation, you can reduce the time, increase lifestyle in the future or increase lifestyle now. Or a combination of them.
Having a process gives you control and it is more objective than, “Wow, I need $600,000, how will I ever do that.”
People act on things they understand and things they feel they control. It is like the process of a child preparing for a career. Go to school and do your homework today. Nothing else is manageable in the present.
The process creates the win.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772