Goal Planning
Perhaps you’ve never heard of Goal Planning? It’s actually an ancient concept but an easy one to grasp. In our case it boils down to this: what boxes do we have to check and what investment performance do we have to achieve in order to retire comfortably?
In my previous article I talked about an investment strategy that I believe should work well for most people. It’s a very aggressive strategy and not to everyone’s taste. But, is it really necessary to “set our hair on fire”? Maybe not. Perhaps a more modest investment strategy, one with a lot less risk, will achieve our goals. That’s what goal planning will tell us.
If you want to retire to a 10,000 square foot waterfront house in Malibu, CA then you’re going to need a lot more money than someone who just wants to putter around the house and visit the grandkids once a month. Not everyone’s idea of retirement is the same. Some people have no concept of what their life in retirement will look like. Let’s take a crack at our checklist.
- What do you want to do in retirement? It’s no accident that this question is first because everything you do will depend on the answer. Don’t know? Guess! If you really don’t know it’s best to assume that you will continue your current lifestyle. You can always change your answer later, but in order to proceed you’ll have to have some “goal” to work towards.
- Create a budget that represents your expenses today. This sounds easy. Everyone knows what they spend on fixed expenses like mortgage, electricity, phone, etc., but many people don’t realize what they spend on variable groceries, restaurants, gas for the car, etc. You may be surprised. When I first started tracking my expenses I was shocked at some of the things I saw!
- Create a budget for your life in retirement. There’s some advice on how to do that below.
- Create a financial projection. This will tell you how much money you should expect to have in the future.
- Create a budget for your current life that will allow you to achieve your goals.
Now we’ve come to the hard part. Until this point you’ve been a passive reader; now you become an active participant.
Let’s assume you’ve decided what you want do once you retire. Congratulations, you have some goal to work towards. Next, let’s make a budget of our current expenses. Why? First, you may want to keep your current lifestyle in retirement and this will give you some idea of what monies you’ll need. Second, assuming you will have a different lifestyle in retirement, your current expenses will give you some sort of jumping off point for creating a new budget. Let’s look at our sample budget.
Note: This budget is completely fictitious and is unlikely to reflect your lifestyle/expenses; in order to get something out of this exercise you’ll have to enter real numbers and real categories and get realistic numbers.
The thing you should notice is that is doesn’t include any savings. That’s because savings is what we’re trying to solve for. Now let’s assume that we’re going to keep this general lifestyle when we retire. Let’s make a similar budget and eliminate all of the things that will no longer be necessary (also shown on the sample budget).
When we compare our retirement expenses with our current expenses we notice that the value dropped by approximately 40%. Why? Well, the kids are out of the house, no more college expenses, the mortgage is paid off, you no longer have a high income so your taxes are reduced, and so forth. If you don’t want to make a detailed retirement budget just take 60% of your current budget and you should be in the ballpark.
Note: All dollar figures are in “today’s” money. We’ll include inflation in our financial projection.
Creating a financial projection is a difficult thing to do. Predicting the future is hard and there are many different methodologies for trying to do so. For our purposes I will show a plan that uses linear projections. I like this methodology because it’s simple and as likely to give a good long term estimate as any other methodology.
The model shown illustrates the following…
- A couple, both of whom are 30 years old
- They will both retire in 37 years at age 67
- They have no retirement savings at present
- They will save $24,000 per year
- Their retirement expenses will be $64,000 per year
- Their portfolio will make about 6% year over year
- The rate of inflation is 2.5% per year over year
- Their combined social security is $58,800 per year at age 67
- Their social security is adjusted upwards by 0.5% each year
- At age 80 Social Security income for person 1 is dropped (someone dies)
The model (PDF version or Excel version) shows that the portfolio balance peaks at around age 67 at just under 2.3 million dollars and there is enough money to last until age 91. The model has a fudge factor that automatically makes it a little more conservative than straight math would. Interestingly the future value of $64,000 (the expenses) at age 67 is about $160,000. Wow!
Of course, in order for these numbers to be meaningful for you, you have to plug in your own values. The spreadsheet contains two tabs: one is assumptions and the other is calculations. If you don’t like the results you got jigger the numbers until you do. Just remember to keep your assumptions realistic or else the model will be meaningless.
You can easily get your projected social security values from The United States Social Security Administration.
Now, go back and play with all of your budgets and plug in new values into the model and see what makes sense for you. These are all meant to be living documents and, if I were you, I would update them all about once a year. That’ll give you a good idea of where you stand. I wish you well!
That should wrap up our series on retirement planning. I hope you enjoyed reading about it as much as I enjoyed writing about it. If it helps you, so much the better. Feel free to ask questions, I love to see people succeed.
(This will be the last time I will say this – I am not a professional financial planner. This article is meant only for illustrative purposes. You should check with your own financial advisor before embarking on any retirement plan.)