It’s really important to have a game plan for your financial future. Once you create a plan and start executing it, you have a lot more confidence knowing you are on track. It feels wonderful and it’s empowering. Fortunately, you can run your own financial projections and I’m going to show you how. Also, I’m going to provide a few spreadsheets that you can download and use yourself. It’s not complicated and it doesn’t even take that long.
But before you get started 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? You don’t have to be 100% certain of these numbers but you do need a reasonable approximation.
2. Inflation. Over the last several years, inflation has been tame. But over the last 20 years, prices have risen, on average, a little over 3% each year. 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 how you invest your money, 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 average returns of the market are about 9% per year, there can be long stretches of over or under performance.)
5. Tax bracket. What bracket are you in now? What tax rate will you be paying in the future?
Do you have questions about putting your plan together? Shoot me an email. Maybe I can answer you directly or write a post to answer you in detail.
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. Assume:
- You spend $4,000 a month (before taxes). That’s $48,000 a year. We will have to adjust that up for inflation.
- You save $500 a month ($6,000 a year), which goes into your 401k.
- You are in the 35% marginal tax bracket.
- 3% inflation rate
- You want to retire in 20 years.
- Your return on investment is going to be 6% on average.
- You have $100,000 saved up in your retirement accounts.
The first step is to estimate how much money you are going to accumulate.
Your $100,000 that will grow at 6% for 20 years and you will add $6000 a year. Here’s what it will be worth at that time:
Now, let’s consider how much income that $551,427 will generate after inflation 20 years from now. Assume that you withdraw 4% of the account value per year once you retire.
That’s how much money your investments will generate in 20 years if all our assumptions are true. Now let’s consider what you’ll need.
You spend $48,000 now. If we assume 3% inflation, what will you be spending 20 years from now?
Tying it all together.
For this example, you’ll spend close to $87,000 but only have about $22,500 a year coming in. Before you hit the panic button, let’s consider other sources of income like Social Security, rent and pension income.
In this case, you have Social Security, pension, real estate and other income which totals up to over $95,000. That plus the $22,500 provides more than enough income to pay your projected retirement expenses 20 years from now. Now you have a plan you can work with! And it wasn’t all that tough to do. Right?
Now, all you have to do is:
- Make sure you save the $500 a month no matter what.
- Keep that real estate working for you.
- Avoid doing something dumb.
- Make sure your expenses don’t climb about your projections (plus inflation).
If your plan doesn’t work, you still have a few choices:
a. Save more and spend less.
b. Work longer.
c. Get a part-time job once she retires.
d. Invest more aggressively (Although, if you already have a reasonable amount of growth equity in your portfolio, I don’t like the idea of getting super aggressive. I suggest you work towards a combination of a, b and c instead).
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 download this retirement calculator spreadsheet. Make your own rough projections and update them yearly.
Have you created your own financial plan? What changes did you make as a result?