The previous two posts considered firstly an evaluation of a person's current financial situation and second an estimate of how much would be needed to fund the desired standard of living without being in paid employment. The third and final step in the retirement calculation is to produce a plan to get from point A (now) to point B (retirement).
In our example, we assumed that an income of HK$40,000 per month would be required and calculated that a 4% rate of return would require a lump sum of HK$14 million to achieve this (HK$12 million to produce regular income and HK$2 million for one off events). The 4% has been based on the fact that in current market conditions it is possible to construct a portfolio of shares and properties that will produce a net yield of 4% before tax. The expected yield is a rather critical assumption and contains some further implicit assumptions or elections which will be examined separately.
The basic calculation is to take (i) the estimated amount which can be saved each month (or year) and (ii) an estimate of the return that can be earned on investments and work out how long it will take to accumulate the required lump sum. An alternative approach is to work backwards - taking the number of years to the planned retirement date and work out how much needs to be saved each month. Many financial advisers use a rate of return bewteen 8-10% for planning purposes. There are many financial calculators avaiable on the internet that can be used to do a simple calulation. Alternatively, a spread sheet can be set up to produce a more personalised calculation.
The next step is to take a look at the outstanding mortgage (and any other debts) and see if the scheduled payments will result in the mortgage being paid off before retirement. If the answer is "no" then either an additional amount will need to be set aside to pay off the residual balance before the onset of retirement. Alternatively, the monthly payments could be increased to pay off the mortgage sooner.
The last step (as with all parts of the planning process) is to ask if there is anything else that may affect the plan that can be readily forseen?
As mentioned, the three step process contains a number of implicit assumptions or elections. It also leaves open the question of how the starting capital and the savings should be invested. These points will be addressed in the next series of posts.