First, you must be passionate about achieving financial independence. It must be a priority for you. You cannot let diversions or obstacles, like those mentioned previously, prevent you from achieving your goal. The very worst possible thing you can do is to put off planning thinking that you will have plenty of time to save for retirement. A multimillion dollar investment portfolio is not something you can accumulate overnight. As you will see in step four, putting it off for eight years can more than double the amount you would need to invest each year to accumulate the same amount of money.
Second, you must establish your retirement income goal in time and dollar specificity. How much money you need to retire is based on an accurate estimation of your expenditures, now and in the future. What type of lifestyle do you envision in the future? Do you want to maintain or increase your standard of living? What amount of income will allow you to do what you want to do?
Third, determine the amount of money needed to provide enough retirement income for the rest of your life. Many people depend on a fixed income stream during retirement. In an inflationary environment, a fixed income stream will not allow you to maintain a constant standard of living. A more acceptable means is to have your income increase annually with inflation. From your retirement income goal, you can determine the estimated target portfolio needed to provide an inflation-adjusted income stream for the length of your retirement life. For example, to receive an income of $150,000 per year increasing at the rate of 3% each year for thirty-five years, you would need an estimated target portfolio of over $2,620,000 earning an average annual after-tax return of 8%.
Fourth, develop an investment strategy designed to meet your goals. How you manage your retirement funds using a diversified asset allocation strategy is one of the most important factors that will help you accumulate the dollar amount required to achieve your retirement income goal. Once you determine how much you need to accumulate, determine how much you should be saving for retirement. For example, to receive an income of $150,000 per year increasing at the rate of 3% each year for thirty-five years, you would need an estimated target portfolio of over $2,620,000 earning an average annual after-tax return of 8%. A 40 year old planning to retire at the age of 65 would need to invest over $35,800 each year for 25 years to accumulate that amount of money. A 48 year old planning to retire at the same age would need to invest over $77,600 each year for 17 years to accumulate the same amount of money.
Fifth, protect yourself from the potential risk of outliving your money. When people retire, they want their retirement funds to last for the rest of their life. Uncertain knowledge of investment returns, length of life in retirement, and rising expenditures make assumptions about the future less reliable. Longer life expectancies increase the potential risk of outliving your money. An extended market decline soon after retirement could jeopardize the sustainability of withdrawals over the life of the retirement period. Meeting financial obligations through an investment-based approach is only one part of the process. Combining a diversified allocation strategy with a guaranteed income stream increases the probability that your retirement funds will last as long as you do.
One of the best things you can do is to start early and stay committed to becoming financially independent. Meeting with a retirement income specialist to plan your retirement needs and objectives and to discuss ways to protect against longevity and an extended market decline will put you in the best possible position to achieve your goals and dreams.
Bill Griffith, Jr., CFP is a retirement income specialist – with expertise in the area of retirement plan distribution strategies, healthcare and long-term care issues. He has practical experience in planning and/or supervising all aspects of a client’s financial planning needs with the goal of protecting and enhancing retirement assets and estates.