You can create your own financial plan for free. You should take advantage of that if you want to retire now or sometime in the future or even if you haven’t given retirement a second thought.
There are thousands of free calculators available on the web that could be very useful to you. (Probably more useful than the $3,000 plan many financial advisers try to foist on clients.)
But before you get started with fancy calculators, you need some data:
1. Spending/Earnings/Savings. What does it cost you to live, on average, every month? How much do you earn? How much do you save? How will that change over time? If you aren’t already doing so, make sure you track your spending every month.
2. Inflation. Prices have risen, on average, a little over 3% each year over the last 20 years. What inflation figure do you want to use?
3. Assets and Liabilities. Before running a financial plan, you must have a balance sheet that lists all your assets and all your liabilities.
4. Estimated Rate of Return. Depending on the asset allocation you use, you need to make some assumptions about the returns you’re going to enjoy. The only way to estimate returns is to do so over a long period of time. Nobody knows what the stock market is going to do this year or next. But you can make some assumptions about the returns over the next 20 years. (Of course, even that is tricky. While the long-term returns of the market are about 9% per year, the last 10 years didn’t come close to that.)
5. Tax bracket. What bracket are you in now? What tax rate will you be paying in the future?
You absolutely can do this on your own. No problem. But if you want some help creating your financial plan, I’m available.
As you can see, creating a financial plan requires lots of assumptions. You make the most reasonable assumptions possible, of course, but they can be wildly off-base. That is the reason I really dislike very expensive financial plans some firms try to sell. They aren’t any good at helping you make decisions now. What is far better is to run simple plans and update them each year as the facts on the ground change.
Let’s take a very simple example. Martha earns $4,000 a month (before taxes) and saves $500 ($6,000 a year), which goes into her 401k. She is in the 35% marginal tax bracket, she assumes a 3% inflation rate and she wants to retire in 20 years. For this example, assume Martha has $100,000 already saved in her retirement accounts. She wants to have the same before-tax income (inflation adjusted) when she retires as she does now. She wants to know if she will reach her goal. Let’s create Martha’s plan by assuming she can earn 6% on her investments, on average, over the next 20 years.
The first step is to calculate how much money Martha is going to accumulate.
She’ll have $100,000 that will grow at 6% for 20 years. Here’s what it will be worth in 20 years:
Now, let’s consider how much income that $554,669 will generate after inflation 20 years from now. Let’s assume she will withdraw 4% of the value of the account each year. Remember, she spends $3,500 before taxes now. She’ll need $3,500 plus inflation 20 years from now. Right?
As you can see, if Martha wants to spend the same inflation-adjusted income in 20 years, she’ll have to generate $6,321 a month. Based on her current savings, she’s about $4,500 short. That’s quite a bit.
Martha has a few choices:
a. She can save more and spend less.
b. She can work longer.
c. She can get a part-time job once she retires.
d. She can invest more aggressively.
I don’t advocate option D. She should probably work towards a combination of all three (a, b and c).
From this example you can see that creating your own financial plan isn’t all that difficult. Once you have a clear picture of what questions to ask yourself, the rest is straightforward. Go through the exercise and find the calculators on the net. Make your own rough projections and update them yearly.
Have you created your own financial plan? What changes did you make as a result?