One of the most common questions that we get when we talk to clients about the current state of their wealth management plan is:
"How much money do I need to retire comfortably?"
As always, an excellent question, but dependent on so many things.
How we build a "Wealth Forecast" is contingent on a number of factors:
1) We need to understand our spending habits now and how these spending habits will translate into future spending .
2) There are plenty of reasons that spending habits can/will change in the future, so we might rationalize this away as an unkown variable, however if we want to live comfortably in the future, we need to understand what "comfortable" costs now.
3) Then we need to build in an assumption about the change of the cost of that comfortable lifestyle in the future. This is the "inflation factor".
4) We will be spending differently on a number of things as we retire: less on children and education (hopefully), more on some of the lifestyle goals that we had set out to achieve.
5) We will also have to plan for the possibility of unexpected costs.
Another important reason to get a handle on our current lifestyle costs is to be able to evaluate our savings potential.
Current after-tax income - current spending = savings.
Compounding is a powerful force as your current savings / investments generate annual returns and in turn become part of the growth process of your net worth.
Commonly known as the "Rule of 72" whereby your savings will double over a ten year period if you can achieve an average annual return of 7% (after fees and taxes).
If you can add annual savings to the equation, the growth curve will steepen with time.
If we extrapolate this curve out to 30 or 40 years, it will continue to steepen at a more dramatic pace.
For you younger folks, this can be extraordinary, if you can find the discipline to save.
Here is where the "forecasting" comes in to play:
You can estimate your savings to your proposed "retirement" date or the time when you wish to start drawing on your savings for your lifestyle needs and then determine your lifestyle spending needs from that point forward. From that, you can calculate how long your money will last.
If the forecast indicates that you will outlast your money (depending on your estimated length of life), you will need to make adjustments (save more / spend less).
If your money will outlast you, then you may have to do some estate planning.
We do a great deal of this forecasting and while it can never be "bang on" accurate, it certainly helps us to be able to make some of the important decisions and visualize the impact of those decisions.
We can create various scenarios to make comparisons.
If you plan to make a major purchase (house, condo, vacation home), it can show you how it will impact your net worth and retirement plan.
It can also help you determine when you can rely less on employment income and more on your savings for your lifestyle needs.
It allows you to get a glimpse into the future, monitor the progress and make adjustments when necessary.
It will show you how much you are going to need.
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist