Preparing for Retirement Takes Some Planning

Planning for a comfortable retirement takes thought and discipline. You can start the process by answering the following questions: How much money will I need for retirement? What will be my monthly and annual expenses? What will inflation do to my nest egg? How much money should I have when I retire? How much money will I get from Social Security and pensions plans from former employers? How much money will my own savings and investments have to provide? How can I ensure that I won't run out of money? These questions prompt another set of equally important questions that include: When should I start saving for my retirement? How much should I invest each year? What investments should I own?

During your working years you'll need to save and invest for your retirement. Your retirement portfolio will grow in dollar value from the new money you add plus from the interest, dividends and capital gains you receive from your investments. You'll learn later in this article that it takes a huge pile of amount to generate a stream of income year after year. Therefore, it's very important to start saving and investing for your future retirement needs at the earliest possible age.

Here are the steps that you should follow to plan your retirement portfolio:

1. Estimate your income for the first year of your retirement from Social Security, pensions and any other sources .
2. Estimate your annual retirement expenses for the first year of your retirement.
3. Compute the difference between your total income and expenses. This amount is what you have to provide from your savings and investments for the first year of your retirement.
4. Estimate how much money you must accumulate to satisfy your retirement needs.
5. Determine how much money you must invest to reach your accumulation target.
6. Set up a savings plan.
7. Set up an investing plan.
8. Execute the savings and investment plans.

Read on to find out how to complete each of the steps.

Estimate Your Annual Retirement Income

Determine all your outside sources of income that you'll receive during retirement. Check with the Social Security Administration and your current and past employers to determine your projected retirement benefits. Also, include any other sources of retirement income such as help from your family or part-time work. Add all these incomes to get your total outside income.

Estimate Your Annual Retirement Expenses

The next step in your retirement planning is to estimate the annual expenses during your retirement. Start by estimating your expenses for the first year of retirement. You'll need to make many assumptions and estimates about future spending but that's part of the retirement planning process. Your estimates don't have to be accurate down to the penny. Just be sure to include all types of retirement expenses like housing, utilities, car, clothes, food, medical, insurance, taxes, vacations, gifts and any other expenses.

The total expenses for your first year of retirement is the baseline for the next step, which is to determine how much money you must accumulate to meet your retirement expenses.

Compute the Amount of Money You Must Provide

To determine how much additional money you'll need to provide from your savings and investments subtract your total expenses from the total outside income. The difference is the dollar amount you must provide. For example assume your outside income is $20,000 per year and your expenses are $40,000 per year. Then you would have to provide another $20,000 from your savings and investments.

How Much Money Must you Accumulate?

After you have determined how much money you need to provide from your savings and investments for your first year of retirement, you can determine how much money you'll need to accumulate. Do the following:

1. Decide how many years you'll need money after you retirement.
2. Select the average inflation rate for the retirement period.
3. Select the average rate of return on your investments for the retirement period.

Given this information, you can estimate how much money you'll need to accumulate before you retire so you'll have enough money to meet your retirement financial needs.

How Many Years You'll Need Money After You Retirement

Answering this question is difficult because you're asking how long you (and perhaps your spouse) expect to live. And no one wants to answer that question. So pick a number, say 30 to 40 years. which is the outside limit of your retirement years - assuming you retire at 65. Don't pick too low a number of years because if you live long enough, you'll run out of money and be old and poor - not a good situation.

Select the Average Inflation Rate

Inflation increases your expenses each year. Some years inflation is high and other years it's low. From 2000 to 2003 the annual inflation rate was around 2 percent, which is relatively low by historical measures. No one knows what the rate of inflation will be in the next 30 years. But you have to make an estimate because we know it will cause your retirement expenses to increase. A reasonable estimate is somewhere between 4 to 7 percent.

Select the Average Investment Rate of Return

No one knows for sure what stocks and interest rates will do in the future. But we do have historical data to help us make reasonably guesses. For example, stocks have returned around 5% to 6% annual returns over long periods. Currently interest rates are at historical lows but probably will increase. So you can use conservative estimate for stocks of 6 percent and interest rates of 5 percent. When you select your estimates, don't be too optimistic about your returns.The prospect of future high returns could lead you to save and invest too little money.

How Much to Accumulate - An Example

Let's assume you need to withdraw $20,000 from your retirement account the first year of retirement- remember the $20,000 is in additional to Social Security and pension income. After that each year you'll withdraw $20,000 adjusted for inflation. This means as inflation increases you'll withdraw in excess of $20,000 each year.

Inflation is included in the analysis because in real time, inflation erodes the buying power of the dollar so $20,000 in 20 years from now won't buy you the same basket of goods that $20,000 will buy today. Therefore, each year you must increase the amount you withdraw to keep up with inflation. For example, an inflation rate of 6% would cause you to withdraw $60,511.99 in year 20 and $108,367.76 in year 30. The effect of inflation can't be taken too lightly. It is the "silent killer" of your long-term financial well being.

The next table shows for different rates of return and inflation rates the required starting balance of a retirement account given you intend to withdraw money for 30 years with a $20,000 withdrawal the first year and a $20,000 annual withdrawal adjusted for inflation for years 2 through 30. At the end of 30 years the balance of the account will be near or at zero dollars. Note:The selected rate of return and the selection inflation rate are assumed to stay constant for each year of the 30-year period.

The worst-case scenario is a starting balance of $3,290,000 for a 0 percent return and 10 percent inflation during the withdrawal period. The best-case scenario is a starting balance of $189,000 for no inflation and a 10 percent return. Both of these scenarios are unlikely. The first one says "keep your money in your mattress" and the second assumes "an almost perfect world". A more likely scenario is moderate inflation and a modest rate of return. For example, a 4 percent inflation rate and a 6 percent annual rate of return for which you need a starting balance of $436,000 to maintain the required 30-year stream of income.

What do these figures tell us and how can we use them to effectively save for retirement? First, it takes a lot of money to generate a long-term stream of income, particularly at low rates of return combined with high inflation. Second, investors who can maintain high rates of returns can start with less money compared to those investors who earn smaller rates of return. Third, you can't control inflation - you can only hedge against it. And the ways you do that are to get high returns and start with a largest pile of money you can. The large pile acts as a cushion.

Investment Schedules - How Much You Must Invest

Now you need to determine how much you need to invest to achieve the target balance for your first year of retirement. The two key questions that require answers are: How much money must I invest each month? How many years must I make these investments? The next three tables show investment schedules for 30, 20 and 10 year accumulation periods. You use these tables to determine how much money you need to invest each month for a given number of years to achieve the target amount of money for your first year or retirement. Each table has five alternative rates of return for the accumulation period.

The tables show the follow relationships between the amount you must invest each year, and the length of the accumulation period, rate or return and the target amount:

• The higher the target dollar amount, the more you must invest.
• The lower the rate of return the more you must invest.
• The shorter the period of accumulation the more you must invest.

Assuming that your investment dollars are limited because of budgetary constraints, you want to make the best use of the those investment dollars. Therefore, it pays to learn about investing so you can increase your returns. Become a committed investor and reap the benefits of knowing how to invest for profitable returns. Also, start investing at the youngest possible age. Although the investment dollars may be difficult to come by when you are young, you don't have to commit as many of them compared to waiting later when you are nearer to retirement. Let time and compound interest work for you.

Here is an example of determining how much you need to invest each month. Assume that you:

• Want to have $500,000 at the first year of retirement
• Will receive a 6 percent average rate of return during the accumulation period
• Have a 30 year accumulation period.

In the following Monthly Investment Schedule (30-Year Accumulation Period) find the column labeled 6 percent and the row labeled $500,000. The cell for 6 percent and $500,000 shows that you must invest $498 each month for 30 years, a total of $179,191.

If you have only 10 years to accumulate $500,000 at 6 percent, the Monthly Investment Schedule (10-Year Accumulation Period) shows that you must invest $3,051 each month or a total of $366,123. So if you put off investing, you must make very large monthly investments to reach a target amount of money for your retirement. To make savings and investing affordable you must start investing at the youngest possible age.

Monthly Investment Schedule for 20-Year Accumulation Period

The following table contains the required monthly investments for a 20-year accumulation period.

Monthly Investment Schedule for 10-Year Accumulation Period

The following table contains the required monthly investments for a 10-year accumulation period.

Monthly Investment Schedule Summary

The following table summarizes the required monthly investments for a 6 percent rate of return for the three different investment periods.

Future Value of a Monthly Investment

Many people set aside a fixed dollar amount each month that they can afford to save and invest. With this approach the amount you invest is dictated by how much you decide to save each month not by how much money you want to accumulate. There is nothing wrong with this approach as long as you know what you'll end up accumulating. If that amount is not enough to start your retirement, then you can decide how much more money you'll need to invest each month.

The following table shows how much money you will accumulate for different monthly amounts invested at 6 percent rate of return for 10, 20 and 30 year accumulation periods.

Like the other investment schedules show, you accumulate lots of money if you start investing early in your life. For example, you accumulate over $300,000 with a $300 per month investment for 30 years. But the same $300 invested monthly for 10 years gives you only $49,100.

Setting up a Savings Plan

You have to save money first before you can invest it. How much money you spend and save is strictly up to you. But remember the more you save and invest at a young age, the less money you have to invest later. We offer no specific advice other than set up a budget, control buying on credit, make saving money a very important priority and save some money each pay period - any amount saved is better than no amount saved. In summary - get into the habit of saving money. The more money that you save and invest at a young age the more money you'll have in your pocket at older ages

Setting up an Investment Plan

buyupside.com includes many articles about investing and making money with stocks. Here are two to get you started: Building Your Portfolio and Key Investing Principles.

Investment Calculators

See Free Investment Calculators for a list of very helpful and easy-to-use investing calculators that will help you make your retirement savings and investing plan.

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