WelcometoLesson 18oftheFundamentalsofPersonalFinancialPlanning.Thislesson maybeadoozy!Butitalsomaybethemostvaluableinthesenseofcalculatingyour retirementneeds.

Disclosure!This isaverysimplemethodofcalculatingyourretirementneedsand/or collegesavings. Thereareplentyofissuestoconsidersuchasthestaticnumbersandratesofreturns. Whenusingthismethodology,youmustusecorrectinputs donotexpectthistobean endall,beall,solution. Ifyoureusingthisasyourguidingstar:youneedtoactuallygrowyourmoneyatthestated ratesofreturnORhigher,oryouwillfail. Ifinflationishigherthanyoucalculate,youmayhaveissues. Whenusingsimplecalculationslikethis,marketvolatilitycanhaveaneffect. Forretirement,thewithdrawalratemethodologymaynotproperlyassumeforinflation.

Idebated foraverylongtimeonbalancemakingthislessoneasybutstillvaluable.I decidedtotakeabitofaleapandwillbeteachingsomevaluablestuff. Thewebsitelistedontheslideshouldprovideaveryturnkeycalculatorthatyoucanuse forcomplicatedcalculations.Youllneedtouseyourstandardcalculatorstoforsimple calculations.

Ifyouareadvancedenough,youcanuseanHP12ccalculator ortheTI12b.Theyreboth financialcalculatorsandcanaccomplishwhatyouneedbutteachinghowtousethemmay beawholeotherlesson.Iamavoidingtheminordertomakethiseasierforyouthe student. Onlyusethehp 12corti12bifyouarefamiliarwithit.IFyouhaveneverusedthem, pleasedonotattempttonow.

ForthosethatarefamiliarwiththeHP12canditsReverse PolishNotation,youwillonly need touseitforn,I,pv,pmt,andfv.Nothingelse. Again,ifyouhaventusedthiscalculatorbefore,thisisnotthedaytostart.

Ok!Sotheprevious lessonscoveredthebackgroundonhowtoarriveatthesenumbers. Inthislesson,wewillbefiguringouthowtousethesenumbers.

Theresreally2questionstothat wearetryingtoanswerforthisexercise.Thesetwo questionsarebasicallythetwostepsinvolvedwithcalculatinghowmuchyouneed. Eachgoalwillhavetwophasesofpartstotheirlife theaccumulationuptothegoal,and thedistributionoffundswhileinthatgoal.Forsomethinglike4yearscollegeplanningfor a6yearold,theaccumulationperiodmaybe12years(fromnowuntilage18)andthe distributionperiodwouldbethe4yearstheyareincollege. Forretirementplanning,theaccumulationperiodisthetimebeforeretirementandthe distributionplanningwouldbetheyearsinretirement.

Whencalculatingthingsforyoursituation,youwillneedtoknowafewthingsupfront. These arejustassumptionsfornow. Youllneedtofigureoutanassumptionthatyouwanttouseforagrowthratethatyour investmentscangenerate.Pleasenotethatyoushouldprobablyuseadifferentrateof returnwhileyoureaccumulating.Thisisnotrequired,butitisprudent.Itmaynotbe prudenttoassumesomethinglikea10%rateofreturnwhileinretirementsincetherisk associatedwiththatmaybetoohigh. Itsimportanttoknowthatplanningforalowerrateofreturn,butaimingforahigherrate ofreturn,maybebeneficialsinceitsunlikelyyoullbedisappointedifyouhavemore money.Onthecontrary,planningforahigherrateofreturnthanachievedwouldalmost certainlyresultindisappointment.

The firstquestionweneedtoanswerishowmuchmoneydoIneedwhenmygoal begins?. Forthis,allweneedtodoisfigureoutwhatcostslooklikeTODAYandthenfactorinflation intothatnumber.Youmayhearmesaythingslikeinflateafigureortodaysdollars. TodaysdollarsmeanswhatitCOSTStoday.Ifweinflateafigure,thatmeanswere simplyadjustingtodayscostforfutureinflation.Asarecap,wedothisbecauseifcollege costsare$5,000ayearintodaysdollars,theywillhaveahighernominalcostlaterinthe future. Thesecondstepistofigureoutwhatthevariousdistributionscenariolookslikebased uponthatannualcostbeingyourpaymentfromyourinvestment.

Insteadofreviewingall thetechnicalaspects,Ithinkthebestwaytolearnthiswouldbeto gothroughanexample andworktheexampletoananswer.Wellgostepbystepsothat youshouldbeabletowriteyourownsituationasanexampleandreplaceyournumbers withthisexamplesnumbers.

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So, wefirstmustfigureoutthedistributionmodescenario. Steponeistoinflatetodayscoststothefuture.

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When inflatingtheannualcost,youshouldhavegottenanumberaround$31,588.15 Thisisjustwhatthelastyearcosts.LikeIsaidbefore,wechoosetheLASTyearsinceits moreexpensivethanthefirstyear.Itbuffersinalltheinflationoverthe4years.

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Collegeplanningisasimple project theresonly4yearstoplanfor. Ifwetakethatannualcostandmultiplyitby4,thenwecansafelyplanfor4years. LikeImentionedbefore,wearefiguringfortheLASTyearinsteadofthefirstyear. Therefore,multiplyingby4shouldgiveusmorethanenoughmoneyforcollegesincethe lastyearshouldbealmost2030%higherthanthe1st year.

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Ok.Sowehave figuredoutthatweneed$126,352in13years.Thenextquestionis how doweaccumulatethatmuchmoney? Whatdoweknow?(Seeslides)

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So,wegobackto ourcalculatorandusetheseasourinputsandwesolvetofigureouthow muchweneedtosaveonanannualbasisinordertohave$126,352in13years. Thisassumesthatwestartwithnothing.Thisalsoassumeswesaveastaticpaymentand earnastaticreturn.Again,thisisaverysimplewayoflookingatthings.

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Didyouresolve thatMary&Steveneedtosave$5,878peryear? Ifso,youdidthatcorrectly.

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IfthepreviousstepsdidNOTmakesense,pleasetakeamomentandrewind,andreview them.Try toseethelogicbehindeachstep.

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LikeIsaidbefore,noticethedifferencebetweenthetwophases.Youneedto gotothe futurefirst,understandwhatitlookslike,andthenfigureouthowtogettoDay1ofthe future.

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Retirement isnotmuchdifferent.Youremerelyusingdifferentnumbersanddifferenttime horizons. Insteadofmultiplyingbythenumberofyearsofcollege,retirementhasamuchlargertime horizon.Oneverysimplewaytofigureoutyourneedsistocalculatetheamountneeded tobegeneratedfromyourinvestmentsandthenfigureoutalumpsumthatcanprovide thattoyou usingawithdrawalrate.

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Seethisexample.

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Referencing thewordproblem,theseshouldbetheinputsyouextrapolatefromthetext.

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Using a$82,713.57neededincome,youwouldneedtoreferenceRobertswithdrawalrate andbackintothelumpsumRobertneeds.

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Next, letsaskthequestion howmuchdoesRobertneedtosaveeachandeveryyear?

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Robert needstosave$2,357/month!Forsomepeople,thismaybealotofmoney.For many,thismaybedoable. Inreallife,wedonotknowRobertorhissituation.Ifheslookingtocompletelyreplacehis incomeandhesmaking$35,000ayearrightnow,saving$2,357/monthmaybenearly impossibleunlesshehassomeoneelsesupportinghislifestyle. Therefore,Robertwouldneedtoconsidereitherworkinglongerorspendinglessin retirement.Ofcourse,Robertwouldwanttoconsiderhisotheravenuesofincome social securitymaybehisonlyone.

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Inthepreviouscalculation,weassumedRobertdidnothaveanysavings. Wecanadjust thecalculationtoallowforanysavingsRoberthasalreadydone.Theonethingtonoteis thatanyFVandPVmustbeoppositedirections thatis,onemustbenegativeandthe otherpositive.Thisisbecauseoftheaccountingprincipalthatyouaredepositingmoney anditisreturnedintheoppositedirection.Youreessentiallygivingthemoney(anegative) inordertoreceivemoneyback(apositive). Ifthatdoesntmakesense,dontworry.JustrememberthatPVandFVmustbeopposites onenegative,theotherpositive.

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If youwereableunderstandandfollowalong,thenyoushouldtakethenextstepandtryto runotherscenarios.Ivelistedafewhere. IfRoberthasahigherrateofreturn,thatshouldrequirelessmoneybeingsavedannually. IfRoberthasalowerrateofreturn,thatwillincreasehisannualsavingsneed. Ifhestartswithalargersumofmoney,thatwoulddecreasehisannualsavingsneed. Orifhehasalowerincomeneedorlongertimetosave,thenthatwouldrequirealower annualcontributionorrateofreturn. Andlastly,ifhehasalowerwithdrawalrate thatwoulddramaticallyincreasehislump sumfigureneededatday1ofretirement.

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So! Withallofthissaid,yourtakeawaywithallofthisisthatyoushouldbeabletowrite yourownstory! TakeRobertsexampleandyoucansafelyuseitasamodelforyourown.Iwanttorepeat forprobablythe10th timethatthisisallaVERYsimplemethodoffiguringyourneeds.Its betterthannothingbutitmaynotincludeeverything.

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Asalastreminder, rememberthatyoumayneedtoadjusteitheryourcollegeorretirement costsbyfiguringforothersourcesofincomethatmayhelpreduceyouroutofpocket needs.

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