By Paul Merriman
At some point, every investor who is planning to retire must confront
his or her financial future. For most people, basic retirement planning
can be distilled into 10 numbers.
As I worked with thousands of
people over the years, and I saw over and over that when these numbers
come into focus, the future starts looking clearer and less mysterious.
you work to nail down these numbers, I suggest you regard the process
as an exercise in discovery. Some items are easy to determine, while
others may require some digging and careful thought. I think you will do
a much better job if you use a competent financial adviser to help you
get the right numbers and see what they mean for you.
current cost of living. This is the foundation of everything that
follows. You could go into great detail on this, but a quick-and-dirty
approach may be enough to get the process started: Identify your current
gross income and subtract whatever you are saving for the future,
including contributions to any IRA and employee retirement accounts.
That's your cost of living, including taxes.
rate of future inflation. You will have to estimate this, of course. We
all know that $100 isn't what it used to be, and inflation isn't likely
to go away. Since 1926, inflation has been 3%. Over the years, that can
do much more damage to your finances than you might think.
number of years before you will retire. This isn't as simple as it
seems. We can't always control when we stop working. And baby boomers
increasingly retire in stages. But getting a useful financial snapshot
requires a number here. So for this exercise, choose a future date when
you want to be financially ready to leave the workforce "cold turkey."
inflation-adjusted cost of living in your first year of retirement.
While you can crunch the number yourself with a financial calculator,
this item can have lots of moving parts.
How will your taxes
change? Will you spend more money on travel and hobbies? Less on
commuting and clothes but more on health care? Will you move in search
of lower housing costs, a better climate or to be closer to your kids? I
suggest you use an adviser to help make sure you have not overlooked
Five: The noninvestment
retirement income you can count on. Probably this will include Social
Security. It might also include a pension or rental income. Don't
include interest, dividends and capital gains; they come into play next.
retirement income you will need from your portfolio. If you have the
first five answers, this one requires only simple math. You know how
much you'll need in that first year of retirement, and you know how much
you can count on. The difference must come from somewhere else, most
likely your portfolio.
Seven: The size of the
portfolio you'll need when you retire. If your investments are properly
balanced between well-diversified stock funds and low-cost bond funds,
you should be able to withdraw 4% of your portfolio annually without
much risk of running out of money.
Multiply the result you
obtained in the previous step by 25. That's how big your portfolio
should be on Day 1 of retirement. If this number seems impossibly large,
don't panic. There are lots of things you can do about it.
The current size of your portfolio, excluding real estate and other
nonliquid assets. For most pre-retirees, this number will be less than
what you will need when you retire. The next items will help you build
Nine: The amount you're saving for
retirement every year. You should already know this from the very first
calculation. If your annual savings plus your present portfolio will
equal the result from Item seven, then you're in fine shape. More
likely, these savings alone won't be enough. That's why you need some
growth in your portfolio.
Ten: The annual return
you need from now until you retire. While you can make this computation
with a financial calculator, I suggest you discuss this point with an
adviser to make sure you have reached a reasonable result.
The point of this exercise is to get a snapshot of your retirement readiness. I found an online calculator that,
while it doesn't cover all the information I have described, will give
you a quick idea of whether or not you are on the right track.
times I have recommended using a financial adviser to help you through
these calculations, and you can do that without establishing a long-term
relationship. You can hire one by the hour to check your work and make
sure you have an action plan to get you where you want to go.
If you do that, these 10 numbers can change your life.