Ensuring a simple but successful financial retirement plan.
People save money throughout their entire working life in the hope that they will accumulate enough to sustain their lifestyle in retirement. How do you know if you have saved enough? One of the best ways of preparing a successful retirement plan is to “begin with the end in mind”.
Retirement planning is a process of determining from where your long-term income will come, quantifying the lifestyle you intend to have and maintain, and most importantly, implementing plans on how to reach those goals.
Income after retirement is commonly measured in terms of the salary replacement ratio – the income you receive from your pension once retired, as a percentage of the income you were receiving just before you retired. A popular guideline is to aim for a replacement ratio in excess of 70%. Usually, investors would have to save 15% of their salaries for their entire working life, in order to have sufficient savings for a comfortable retirement. Saving is, however, not the only consideration to ensure a successful retirement plan. Other important factors include the choice of correct asset classes, the realisation of projected returns, the effect of a slump in the market just before retirement, and the effectiveness of a life staging strategy.
These days, with zero interest rates commonplace, it makes sense to consider adopting an income focused investment style. This allows you to focus on the future income produced by your savings, rather than a future capital value, to replace your current income at retirement.
A 2014 Harvard Business Review endorses an income focused investment philosophy. The review states that “our approach to investing is wrong. We need to think about monthly income, not net worth”.
So how exactly do you achieve a reliable and sufficient income stream, regardless of economic conditions or market volatility? You will have to pick stocks of companies which focus on basic daily necessities, enjoy nationwide sales and distribution, and have strong, cash-rich balance sheets. These investments have the ability to perform in bull and bear markets and are relatively less influenced by new ideas, trends or fashion. Ultimately, such a strategy should translate into reliable, growing dividends in your retirement portfolio.
In a portfolio with such ‘year-round winning’ stocks, it is easier to project both income and capital with a higher degree of certainty. The investor will have a realistic expectation of what income their capital could generate, and the projected capital value at retirement. You can adjust the figures to account for inflation, and determine if additional contributions will be necessary to sustain your desired lifestyle. In this way, progress towards reaching your retirement goals can be monitored to ensure your retirement plan will be a success.
You must be able to tell, with the highest possible degree of certainty, what your monthly income and capital value at a projected retirement age will be. Determine the present value of retirement income and capital, and the projected salary replacement ratio at retirement. This will in turn allow you to prepare for the possibility of a market decline before retirement, and ensure that such an event will not diminish the value of your retirement income.
This simple but effective strategy can reduce the complexity of financial retirement planning. It can also substantially eliminate the unpredictability that can make retirement planning so problematic, and allow you to build your retirement nest egg with a reasonably high degree of confidence.