Make Your Money Last series - Step #2: Create Your Financial Plan
This is the second installment of our series on Make Your Money Last, which we believe is shaping up to be perhaps the greatest financial challenge faced by the next generation of retirees.
In Step 1, we advised you to plan your retirement before you retire. Now, let’s look at what your plans for retirement might cost. So, put pencil to paper and construct a budget.
The next step is logical: Turn that budget into a financial plan. That’s when retirement planning really gets interesting! Now the rubber meets the road!
Be Realistic
Financial plans are filled with pitfalls. It’s just one trap door after another. So, be realistic. You certainly don’t want to base your financial plan on a bare-bones estimates of expenses or overly optimistic expectations of portfolio returns. Financial surprises will happen during retirement; it’s not a question of if, but when. So, build in cushions for those surprises. The last thing you want to do is to retire, spend too much in the early years of retirement and find that you can’t make ends meet later in life.
The other “last thing you want to do” is to figure out your financial plan by hand or with inferior software. Financial planning is very complicated, there are tons of moving parts. Don’t fall into the trap of thinking you can do this on the back of an envelope – you can’t. You need top quality software to get the job done. We use e-MoneyAdvisor. It enables us to tailor-make financial plans to custom fit the nuances of your life. It’s expensive, but it’s worth it – this is one calculation you don’t want to get wrong.
Focus on What You Can Control
As you work through your financial plan, keep in mind there are generally five levers that will determine its success or failure:
Longevity
Inflation, Especially Healthcare Costs
Investment Returns
Length of Your Career
Spending
Unfortunately, you can’t control the first two levers: Longevity and Inflation. While you cannot control how well the investment markets do, you can control how well you execute on your investment plan. Most investors are their own worst enemy: they buy when prices are high and sell during market panics. As a result, the typical investor tends to reap less than half of the investment returns they could get for the risk they are taking. We will have much more on this research in future blog articles and videos.
Ironically, the two levers that can make or break a financial plan are the two least fun to consider: How long you work and how much you spend. The length of your working career has two positive effects:
1) Adding potential savings; and
2) Reducing the amount you need to withdraw from your portfolio for living expenses.
Spending is usually the biggest factor in a financial plan. Why? Because each year of reduced spending cuts the amount you need to withdraw from your portfolio. Even minor changes in spending can have a huge impact on your financial plan.
So, invest wisely and focus on what you can control: How long you work and how much you spend. If you do that, you’ve got a much better chance of enjoying your retirement.
