Assalamualaikum (Peace Be Upon You),
My major disclaimer is that though I have a certificate in financial planning, I'm not a certified financial planner per se. The bits below should be taken at face value, till you meet a certified financial planner (who's actually certified by an established financial planning body like the CFP and the like). Unfortunately, in Brunei, financial planning is currently unregulated, making trusting planners somewhat more difficult. But just to add some cred(ibility:) to what I'm saying, I'll nerdily add 1 or 2 references along the way.
My actual intention is just to highlight some "simple" steps to plan your retirement (It actually may not be simple, they'll be numbers, calculations [Thanks goodness for websites] & maybe the odd, irrelevant diagram). Let's start w/ a scenario: Say, I'm currently 25 (Du bi du) & I want to retire at 55. I have a fictitious TAP (an Employee Provident Fund) of $20,000 & an investment deposit of $10,000.
Step 1: Estimate your retirement expenses
- Some planners & finance websites might provide a rule of thumb like "An easy rule of thumb is that you’ll need to replace 70 to 90 percent of your pre-retirement income" (p.7).
- Although rules of thumb are handy, it might not be for everyone or be too rigid (e.g. post-retirement may see higher or lower actual expenses due to health costs, vacations etc).
- The better thing, according to Mittra, Potts & LaBrecque (2005), is to work out an expected expenses figure. Look at your monthly expenses, break it down to fixed vs. flexible expenses, create key categories & estimate a figure for each category.
- In this scenario, let's say mine works out to $3,000 per month or $36,000 per year. This is how much I need each year after retirement.
Step 2: Calculate the lump sum needed at age 55
- As I'll need $36,000 per year until I pass away, I need to know how much I ideally would like to save by 55. In a sadistic world, I'll need a financial calculator, face some mental anguish but thanks to the internet, let's use this webpage. Imagine we're at year 2041, when I'm umm 55. Put in the following figures:
- Present value: Leave it zero (Cos we want to find this figure - This is the lump sum we need to have saved up by 2041.)
- Future value: I'm putting $10,000 here, assuming I want to leave it as inheritance money.
- Number of payments: 20 (Assuming I withdraw a fixed amount per year & my life expectancy is 75.)
- Payment amount: $36,000 (I want $36,000 per year after retirement.)
- Profit rate: I'll put in 0.98% (Inflation-adjusted profit rate)
- Payment at: Begin ('Cos I want to receive the 36k at the beginning of each year.)
- Press the PV icon, which is the present value, which in this scenario is the lump sum I ideally would like at age 55 = $665,557.26.
Step 3: Estimate your retirement income
- Question is: With my current TAP + savings, is it enough to climb up to cover that lump sum?
- To simplify, I'll combine the 2 investments in this calculation. Assuming I want to save B$500 per month on top of the 30k, from age 25 to 55 (that's 30 years) & the estimated profit rate of the investment is 6%. Using the same website, enter the numbers (In this scenario, we're back in 2011, aged 25):
- Present value: -30,000 (Put a negative sign 'cos money is going out.)
- Future value: Leave it zero (We want to find this figure)
- Number of payments: 30 (Assuming I invest a fixed amount per year, not per month.)
- Payment amount: -6,000 (500 x 12, Put a negative sign 'cos money is going out.)
- Profit rate: 6% (Inflation-adjusted profit rate).
- Payment at: End ('Cos I want to invest at the end of the year.)
- Press the FV icon, which is the future value, which in this scenario is your actual lump sum (should your investment assumptions fall into place). You would get $646,653.85.
Step 4: Reconcile the difference
- With an estimated retirement nest/income at $646,653.85, & the required nest/expense at $665,557.26, that means there's a deficit of $18,903.41. In reality, there's a lot of options to deal with this. E.g. retire later, try to earn more, lower your retirement expenses, reposition your investments, take more risks, save/invest more etc.
Step 5: Review & update your plan periodically.
- Things happen. E.g. Investment rates may go up or down, or I may decide to retire later. It's always advisable to review your plan to make sure you're on track.
Step 6: Meet an actual, certified financial planner
In this scenario, I used some of my own assumptions e.g. I only deposit at year end, instead of month end. I assumed my investments will go up per year at 6% etc & ignored the newly introduced SCP in Brunei. So here comes the corny line:
If there's one thing I would like you to take away from this boring post...(assuming you've survived)....is to meet a decent certified financial planner & gauge your actual retirement needs. It might be depressing knowing all the money you need to save or changes you have to make, but it's better to bite the bullet now, rather than face the ultimate bullet later on in retirement.
[Fuh, it seems like a long post. I can continue my life now.]
[ps Lemme know if anyone spots any errors.]
[ps2 I lied. I couldn't find a decent, irrelevant diagram...but I could find this link, which would have saved 20 minutes of your life, rather than reading this post :) ]
Offline Reference:
Mittra, Sid, Potts, Tom, & LaBrecque, Leon (2005). Practicing Financial Planning for Professionals. Michigan: RH Publishing
Peace,
Umar
