Retirement Planning - Before The Numbers

When planning for retirement, the first question on everyone's mind is, "How much money will be needed to fund a comfortable retirement?". That makes sense, but how you arrive at that number is far more important than the number itself. With all of the  moving parts of a financial plan, most involving forecasts of what is likely to occur in the future, being realistic and conservative with your expectations will ultimately determine how reliable your results will be. In addition, financial calculators that ask only 5-6 questions, or "planners" on financial sites that ask a few additional questions, will in no way offer any degree of reliability or accuracy. The idea is to generate a thorough, detailed assessment of your finances, year by year, for decades, not to just get a quick single number target that ignores essential information. That doesn't mean that a comprehensive financial plan needs to be difficult to create (it doesn't), just that you need to account for as much information as possible in order to get the most reliable results. You don't want o get into your later years only to find that your savings are running short of what you will need.
As you start developing your plan, keep these considerations in mind:

• Of course, start by using a comprehensive planning tool designed to create a financial plan. There are so many impactful variables that influence the end result that back-of-the-knapkin figuring, or less than robust financial tools, will only prove to be misleading. Be thorough and use the best possible information at your disposal. The level of due diligence needed when creating your plan can be reflected in the famous saying, "Garbage in, garbage out." The more accurate the information you enter, the more accurate the results will be, and vice versa. Also, the more inputs your planning tool allows, the more variables will be accounted for, and the  more reliable the results will be. Generalizations, like using the same investment return rate for the next 25 years, could easily skew your results by hundreds of thousands of dollars (varying your return rates to reflect the overall average that you expect is far better). The future is unknown, and predicting what might happen is certainly not an exact science, but that doesn't mean that it's okay to fly by the seat of your pants. What it does mean is that more care is needed in preparing for it, not less. Take your time and think things through. A well informed forecast is far better than a guess.

• Be disciplined in your approach. This applies not only to technical aspects involved in creating a plan (accounting for enough variables), but also to creating a plan that you can consistently adhere to. Planning to save $1,000/month won't do you any good if you are only able to save that much some of the time. Planning to reduce/eliminate credit card debt within 2 years, thereby increasing your ability to save, is a poor plan if you can't actually accomplish that. You get the point. Plan based on what you know you can achieve, not what you hope to achieve. You can always revise your plan upwards, or strive to do better than planned, but needing to revise a plan downwards is disappointing, prolongs achieving your goals, and is a real confidence buster. Be realistic, be conservative, and be honest with yourself.

• Know, and track, your monthly expenses and cash flow on a regular basis. This works in tandem with the points above, but if you don't know, specifically and with certainty, how much you currently spend and save each month it will be difficult to set realistic goals and actions for the future. Current spending is the foundation for how your spending will likely change as you get older - even before retirement - and how expenses will end, start, and change during retirement. Estimating realistic expenses over time is half the battle of creating a solid financial plan.

• Be sure to account for Federal and State taxes on all distributions from tax-deferred savings accounts (401k/IRA's). Taxes on these distributions are rarely mentioned in retirement advice columns but they can be one of your largest expenses in retirement. If you have $500k in a 401k, only $400k may ultimately be spendable, with the other $100k going to taxes (these amounts are examples only, as your tax status will determine the actual tax liability). Even with a lower tax rate this can make a very big difference in how much of your savings will remain available to pay expenses, and how long your savings will last.

Also, depending on your total income (including distributions from traditional 401k/IRA accounts), a portion of your Social Security benefit may also be taxable. Using ordinary income, cash and Social Security income in combination with taxable distributions can help to keep your tax liability to a minimum.

• Once you have a plan in place, how you invest your money is the next priority. It's important that savings continue to grow and can provide additional income. Specific choices should be driven by your risk tolerance and short and long term objectives, but the following are some general "best practices" that have been proven to be consistently beneficial:

• Diversify your investments. With the uncertainty of the markets it's never prudent to "put all of your eggs in one basket". By  diversifying into different stocks and/or categories of mutual funds and/or mix of stocks and bonds and/or other financial vehicles you can increase the odds of having some investments on the rise (or at least less volatile) even when others may be falling. This can provide more stability for your total investment balance, as well as steady appreciation over time.

• Be aware of mutual fund expense ratios. Expense ratios in and of themselves are not a reason to shun a particular fund, but you need to be aware of their impact on your net result. While it is not uncommon for higher performing funds to also have higher expense ratios you certainly would not want a lower performing fund to have a high expense ratio. The greater the expense of owning the fund, the more it deteriorates the benefit of it's returns. Funds with higher performance and higher expenses can also tend to be more volatile as they often take on more risk. That can be okay, but just remember that the expense ratio is a direct cost to you whether the fund makes money or not, so the lower the cost of owning it, the more money you keep.

•  Consider high dividend ETF's as a core part of your investing strategy. As markets rise and fall, knowing that you can expect a consistent amount of income from your investments provides stability to your overall plan. Depending on the fund, dividends may be paid either quarterly (most common), or monthly. There are also individual stocks that pay high dividends, but using a mutual fund for income purposes helps to stay diversified, and can also reduce possible volatility. Even though dividends will be paid regardless of whether the market price of the fund/stock rises or falls, individual stocks will always be more susceptible to rapid price movements due to specific company news or other external factors. Keep in mind that while you may purchase a fund because of its dividend you are still looking for capital appreciation as well. High dividend funds tend to increase in value slower than other funds (e.g. growth funds), but they should still have a record of steady capital appreciation in proportion to the general markets. A lack of regular appreciation will offset the advantage of the dividends, so you should look for a good balance between the dividend rate and the long term appreciation rate.

Ideally, the decision of when to retire should be based on assets, not age. When asked when they would like to retire, most people mention a specific age, but the age they choose is often based on desire rather than financial  preparedness. The goal is to be as certain as possible that your savings are sufficient - including the income they will generate - to sustain you for the next 25-30 years. Reliable income, assets (savings), and expenses are the components that should be the driving factor for making such an important, and usually irreversible, decision. You only get to retire once, so base your decision on tangible factors, not emotion.


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