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

Last week we commenced discussions on how much we may need in retirement by bringing out some of the reasons some persons do not plan for retirement as well as what some of the benefits of planning are. Today we will take up a basic model of working out our retirement number.

A first key issue about computing our number is that the thought process of working out sensible assumptions are in themselves enlightening; Secondly, working towards achieving the numbers is empowering; Thirdly, the number we arrive at will be only as good as the assumptions we make; Fourthly and finally, we should accept that we can’t really predict the future accurately but this doesn’t eliminate the imperative to plan. What we should focus on is how acceptably good we can plan based on reasonable and sensibly realistic assumptions. According to a 2020 survey in the US, only about 42% of workers have ever tried to work out their retirement ‘savings’ needs. On the other hand, about 50% of those who actually calculated their numbers took action to increase their savings. In our environment, chances are that the former statistic would be way worse and consequently the latter also.

What we will be doing in computing our number is creating a scenario that prompts us into taking deliberate actions towards achieving desired goals rather than being blown around by winds of life that we haven’t made any attempt at foreseeing or understanding.  We will start with the simplest model that comes with basic assumptions, and over the next few weeks gradually iterate into more ‘sophisticated’ models that try to address some of the weaknesses of today’s and later models.

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‘Retirement Number 101’: The simplest model for computing our retirement number work as follows:

1. Determine what your age is now. Let us assume you are 45.
2. Determine when you want to retire. Let us assume age 65 (assuming your workplace allows that. If not, assume the allowable retirement age except you plan to continue working in some way or form).
3. Based on 1 and 2 above, you have 20 years (that is 65 minus 45) to build the investments you need to see you through your retirement.
4. Now, determine what you already have in investments. Let us assume you have N22 million Naira in retirement investments.
5. Determine what your current monthly budget is. Let us say it is N300,000.00.
6. Assume you will live to age 85 (according to Statista, the life expectancy in our country in 2023 was 61.79 years, but we know that people live up to and beyond 85. Besides it is safer to assume more than less years). That means you will live for 20 years in retirement (death age 85 minus retirement age 65).
7. Based on 5 above you will need N3.6 million annually in retirement. (N300,000.00 multiplied by the 12 months in a year).
8. Based on 7 above, you will need N72 million at the beginning of your retirement. (N3.6 million annually multiplied by 20 years in retirement).
9. But you already have N22 million in investments. (See 4 above).
10. Based on 9, you will need to cover a gap of N50 million (N72 million minus N22 million) within the rest of your working 20 years (see 3 above).
11. The shortfall of N50 million over 20 years translates to N2.5 million annually or about N208,333.33 monthly that you will need make up in new/additional investments.

Now even if N208,333.33 monthly, N2.5 million annually or N50 million over 20 years scares you, at least you now know where you are. Besides, you can look back and realise that you were able to invest N22 million from when you started work/business, let’s assume at age 25, to now at age 45. That means you were investing about N1.10 million annually over 20 years. As we age and gain more experience and skills in what we do, our chances of making more money, even more efficiently actually increases. So, now you may not need ‘to double your efforts’ but to leverage on what you already have, perhaps seize a few more emerging opportunities. Without knowing your number in advance, on the other hand, you may only realise that you have a massive shortfall after you retire and things may begin to get difficult.

‘Retirement Number 101’ above introduces the thought process behind computing what we need in investments for our retirement. However, it obviously has glaring weaknesses some of which are as follows:

1. Assuming that current budget reflects what we will be spending in retirement is not realistic on many fronts. For one, the spending structure and quantum between a forty-five year old and a sixty-five year old are markedly different. Similarly, the elderly are wont to spend less on most account categories but likely more on medical.
2. Related to above is that our chosen retirement lifestyle plans may actually involve spending a lot, such as on travels, social services, etc.
3. We are working everything in current Naira and have not taken inflation, a deadly retirement planning factor, into account. On the other hand, we are also not assuming any growth in investments and economic downturns.
4. No tax deductions, where applicable, are assumed.
5. No other new incomes you may earn within retirement such as in some business are assumed.
6. We have assumed that the individual may live for twenty more years after retirement. That means the person is covered up to age 85 but will be out of funds if they outlive that!

Next week, we will take up our ‘Retirement Number 202’ and try to improve on the assumptions above for better estimation.