Last few months I have been planning for my retirement. Soon I realized that it is a bigger problem than we all would have anticipated. Our generation would outlive our retirement funds. What would I do if I run out of money between the ages of 75 and 85? And what if I live beyond 85? Well, one hundred million fellow Americans are going to face this problem between 2040 and 2050. So what did I find out about retirement planning?
In my supermarket, there are 10,000 unique items, of which, I might need 50 to 100 items. Similarly, there are 8000 mutual funds to cater to various needs. Mutual funds are more than stocks traded. Now the question is — what would be your strategy to shop in your supermarket and in the financial market? It turns out it is pretty similar.
Assume that you like ice-cream — Who doesn’t? How would you know which ice-cream tastes best? Of course, you will try out a few things. Still, you are not convinced that you are buying the best ice-cream. Then one-day your friend suggests that they tasted “THIS ice-cream” and it is the best. So on the next shopping trip, you buy “THIS ice-cream”. And you agree that this is the best ice-cream. Thanks to your friend that you found the best ice-cream. Without your friend, you might be continuing your search out of 50-odd ice-creams in your supermarket. Now think about financial products. Don’t you think you should be picking financial products the same way? You should, if not you are exploring in the wilderness. I can hear you saying — retirement planning is not ice-cream. You are right, ice-cream analogy ends here, by answering the better approach to choose a product. Now starts retirement planning.
How much you need? How long you need? And through which vehicle you need it? It is easy to answer if you know all that can be known about the future. When you don’t know how much you need and how long you need it, then the plan you have chosen might not be the best one either. Add to this, all the future unknowns. So what would be a solution here?
Let us start thinking about it in two ways:
What will happen to our money?
And, what will happen to us and our dependents?
First is what will happen to our money: Our retirement money is going to be in one of the many financial products. That means it is exposed to market risk. If you are planning for more than 15 years, then it is certain that the market would crash once. Which means the market would lose 40% of its value. Now to get back to the original value it would take another 7 years or so. Effectively your money does not grow much. At the end of 15 years, you are not better off than the money you invested. Time did not help you here. It is just that Mr. Market smiled at us. Most of us take comfort that we are not worse-off than the next person. Somehow it convinces us.
While I was talking about 15 years of retirement planning did you think what will happen to inflation? Well if you thought that, then you are financially savvy. If not, the question you should ask is — what will be the purchasing power of $1 in 15 years? Will my fund carry forward the purchasing power of the current $1 to the future? How can I make sure that my retirement fund can overcome this inflation? Market risk and inflation are the two questions that you should be thinking about your retirement funds. Bye the way, we still did not answer the original question of how much money and how long we need it. We are just discussing how to preserve the value of what we are saving!
Second is what will happen to us: How we will progress in our life? What eventualities we should account for — our job changes, children’s education, vacations, hobbies, medical expenses, estate planning, retirement income, don’t forget taxes and other unique circumstances. If you look at any of the life-changing eventualities you need some amount of money. You should work out what your financials should look when you are at 85 and work backward on the many what-ifs that will lead you to the age of 85.
By working through these two critical questions you have a good shopping list to choose from 8000 odd financial products. Choose your best ice-cream. Most likely that it is your friend who would lead you to the best ice-cream. Be prepared for it and make use of it.
I still did not answer my original question — how much money you need and how long you need it and through which vehicle you need it? This calls for an individual consultation. If you know your what-ifs then there is a way to protect against it. That is where your friendly neighborhood financial consultant can help you. If you are above the age of 50 you should start to iterate your plan, if you are above the age of 40 then you should act immediately if you are above the age of 30 you should quantify your short-term responsibilities and if you are above the age of 20 make the best of wilderness.