Questions by Martin Hawes
How much do I need for retirement?
This is one of the big financial questions: we all need to set a goal for our ‘freedom figure’, but just how much do we need to be able to enjoy our retirement? The answer is complicated and there are many variables that come into play. Certainly, you can work out what you need but you have to make a range of assumptions for things like whether you will work a bit in retirement, what house you will live in, what will you get from NZ Super, what will investment returns be, inheritances ….
Sunday Star Times September 2012
Retirement Income Goal
A recent survey has found that around 50% of us are worried that we will not reach our retirement goals. To me, this poses a big question: have people established the right goals – have they been able to calculate the correct amount of capital that they need to get the desired income?
It is easy enough to work out how much income over and above NZ Super that we need in retirement: we simply do a budget for our expenditure and deduct the amount that we will get from NZ Super – what is left over needs to be funded from somewhere else: either from continuing work, or from the returns on investment capital.
The amount of investment capital that you will need to make up the deficit is dependent on two things: first, the returns that you will get on your investments and, second, what you want to leave to the children by way of inheritances.
The amount of returns that you get on your investment capital always depends on the amount of risk that you are prepared to tolerate. Investors in retirement will want to keep their risks fairly low: very few in retirement will take greater risk than that of a Balanced investor – moving into a growth profile is likely to see too much volatility.
Balanced investors have 50% of their portfolios in shares and property and the rest in cash and bonds. Actuaries have measured the performance of such portfolios over long periods of time and have found that they should expect 8% returns before tax and fees. This does not mean that they will get these returns year in year out – there will be volatility and the retired investor will have to cope with that (if they cannot cope, they should accept lower returns and become Conservative or even Defensive investors).
This return of 8% will be taxed which will bring it down to about 6% and there are likely to be fees payable to advisers, brokers, managers etc. which will further lower returns. It reasonable to expect a return of 5.5% after tax and fees. That would mean that for each $100,000 of investment capital you have, you would get $5,500 per annum or $105 per week.
However, this does not allow for inflation – the $105 per week that you get when you first retire in 2012 will gradually reduce in spending power and be worth a great deal less in, say, 2032. If you want to maintain your capital and your spending power in real terms, you will need to add back the amount of inflation – assuming an inflation rate of 2%, the 5.5% return reduces to 3.5% and your spendable income to $67 per week for each $100,000.
The second factor is the inheritances that you want to leave. Many people are happy to plan to leave just the house to their children, spending all of their investment capital to go out on the last dollar. In a practical sense, this is not easy as most of us do not know how long we are going to live and, of course, we do not want the money to run out before we do.
Although, average life expectancy means that we need our money to last about 20 years, most of us will be careful (some might say hopeful) and plan for making it last 30 years.
Assuming 30 years, ignoring inflation and working on investment returns of 5.5% p.a., each $100,000 of investment capital ought to be able to give you income of $6,900 p.a. or $132 per week. Again, inflation will erode the spending power of this $132 per week, however, there are people who do not worry about this as they plan to spend less as they get further into retirement and are less active.
Although you can give basic rules of thumb for how much capital you need, when it comes to the detail the calculations are specific to the individual and not necessarily easy. Moreover, there will be changes throughout retirement as markets become volatile or inflation rises and falls. Nevertheless, I think one of the most useful things that you can do in finance is to set a goal for the amount of investment capital that you will need in retirement – it may not work out neatly and perfectly, but it does give direction and something worthwhile to aim at.
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