Financial planning – How much do you need? (I)

“If you don’t know exactly where you’re going, how will you know when you get there?” – Steve Maraboli

Over the last few weeks, we have discussed the principles and practices of finance and investment planning for retirement during our working careers. However, we haven’t established what our financial needs might be in retirement in the first instance. Beginning today, we will try to discuss how we can get about doing this. 

Why don’t we plan for retirement? For many of us, we plan to go to school, decide which career paths to take, get married, etc. but do the minimum we can get away with as regards retirement planning.  There are many possible reasons for this. 

A study at Leeds University, England, conducted under the auspices of the UK Money and Pension Service, MaPS, to allow MaPS to develop a further understanding of fundamental barriers to retirement and later-life planning concluded as follows: 

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1a. Psychological barriers include inertia and procrastination caused by Decision Complexity, Ostrich Effect and Regret Aversion. Decision complexity is caused by what some consider the complex nature of retirement planning while the ostrich effect and regret aversion are respectively about individuals wanting to avoid disappointment and the preference for doing nothing due to uncertainty and to avoid negative feelings arising from the planning chores.

1b. Changing preferences over time: Naturally, our preferences may change over time. However, some individuals may lack the self-control required to look into the future and make advance choices necessary for planning. This is worsened by bias for the present which makes those individuals emphasize ‘today’ without much regard to delay gratification for distant goals. 

1c. Perception of delayed benefits: Individuals could be disconnected from their future, often concluding that they will have more money in the future regardless of what they may have now or what they may be doing about it. Another dimension to this is the perception that retirement is a long way into the future and not much emphasis is placed on its planning.   

2. Socio-economic determinants of retirement planning are deemed to include financial literacy, education, income level, age, and gender. It was found that there is a strong positive relationship between financial literacy and retirement planning. Similarly, higher levels of formal education and income are strong predictors of the likelihood of planning for retirement. As regards age, older people tend to think and plan more about retirement than younger persons. However, gender was not found to be a significant predictor of the inclination to plan and save for retirement. (I would think though that the results on gender might be at least slightly different in societies like ours where there is a gap between educational level, wealth levels, and societal expectations on the responsibilities of the genders. But of course, this would be subject to scientific confirmation or otherwise.)
3. Other attitudes that influence retirement planning include trust in institutions, state pension uncertainty, life expectancy, future time perspective/retirement goal clarity, and intrahousehold interactions. 

High levels of trust in financial institutions and systems of a local economy can encourage long-term savings in those institutions and other investment activities. Interestingly but not unsurprisingly though, a high level of trust in government was found to lead to lower pension savings by individuals who would keep the hope that the government would not ‘let them starve’. It was found that life expectancy also affects the extent to which an individual can be a ‘planner’. Having clear retirement goals leads to better planning and that individuals are influenced by the beliefs and preferences of other household members. (Beyond household members, I would think that those close to us such as colleagues can influence our retirement planning activities as well. Again, this would be subject to scientific confirmation or otherwise.) 

Other reasons that may make retirement planning difficult include the feelings that ‘I don’t need to’, ‘I can’t even cover my needs now, why bother about something in the future?!’ Other times it is either the belief that ‘it is too early’ or ‘it is too late for me to plan anything!’

Why should we establish what we will need in retirement? The benefits of planning for retirement are many. These include: 

• We can retire ‘early’ irrespective of policy or regulatory requirements. 
• The risks of forced disengagements will be minimal on us.
• Our ability to take care of our needs, desires, contingencies, and particularly the capacity to address our likely increasing medical issues as we age can extend our life expectancy.
• ‘Life renewal’: Every transition in life, retirement no exception, offers a great opportunity for renewal of our lives. But there is a proviso: We must plan the transition and the journey therein.
• Taking care of inflation: Whilst deflation is possible in an economy, human experience, in the long run, seems to suggest that inflation is more of a reality in our lives, almost akin to ‘death and taxes’! A good retirement plan will foresee inflation and put in wise measures to best take care of it. 
• Enjoy the benefits of compounding: Early planning especially as regards finances makes it possible for us to benefit from the compounding effects on the returns on investments we make over the years. 
• We need to plan if we want to be able to maintain or even improve our standard of living in retirement. 

A key aspect of financial planning for retirement is determining our retirement number, which is that theoretical pile of investments that we need to have to live the retirement life we envision. There are various iterative models for coming up with this number and we will take up a few next week.