Most people love the feeling of saving and achieving returns on their money, but this does not necessarily mean that they will have financial freedom when they retire
Do you ever ask yourself if you’re saving enough to live the lifestyle you want in retirement and at what age you’ll be able to retire?
Do you know how much you will be able to live off and how long your capital will last? If you want a strong handle on whether you’re on the correct path to living the lifestyle you want in retirement then lifestyle financial planning (LFP) is for you.
LFP is a goal-based investment plan used by certain financial planners to help clients achieve their investment goals and objectives. A client tells the planner at what age they want to retire and the monthly income they’d like to live off (in today’s money).
This monthly amount is usually based on their current expenditure, but takes into consideration that in retirement large outflows such as mortgage repayments will probably no longer be there. The model uses inflation to forecast this figure to retirement age, creating an investment goal.
How do you reach your retirement goal?
Reaching this goal is predominantly reliant on three things: time, real return and contributions.
- How many years can you invest for? The longer the period of time, the greater the compounding effect in your portfolio.
- What real return (return above inflation) can we achieve? The higher the real return, the quicker your money will grow in real terms. Unfortunately with a greater real return comes greater risk, so this needs to be balanced and understood correctly when speaking with your financial planner.
- How much are you able to contribute? Quite obviously, the more you save now, the more you’ll have in retirement.
All three of these factors play a large role and need to be taken into careful consideration, as they will ultimately determine whether or not you achieve your investment goal. Arguably one of the most important of these factors is time.
Is time on your side?
A person who has limited years to invest and wants to live off a significant amount in retirement is unlikely to achieve their goal, so the key is to set up a financial plan early in life.
Let’s take two simple examples to illustrate the effect that time has on your financial plan. Tom is 21 years old and is able to save R1 000 per month.
He continues saving R1 000 pm until he retires at age 65 and this contribution escalates by 6% every year. He was able to achieve an annual return of 12% on his investment (if we assume the inflation rate to be 6% then this equates to a 6% real return).
Tom’s aim is to live off R20 000 per month after tax when he retires (in today’s money). Based on this scenario, LFP can show Tom that he will be able to achieve this lifestyle for 15 years after he retires. His capital will run out at age 80.
Now let’s take Xolisa, age 35. Xolisa enjoyed spending his money in his twenties and early thirties and has only now started to think about saving for retirement. Xolisa has the exact same retirement lifestyle objectives as Tom and can also only save R1 000 per month, escalating annually by 6%. He also achieves a 12% return (6% real return) on his investment. By using LFP, Xolisa can see that he will only be able to live the lifestyle he wants for 4 years after retirement age. His capital will be depleted by age 69.
By starting his retirement plan 14 years after Tom, Xolisa has drastically decreased the amount he can live off after he stops working. For Xolisa to make up for the 14 years of not saving he will either need to retire later, live off less in retirement, start saving significantly more now or take more risk on his money by targeting a higher return.
Keep revising your plan
LFP is not set in stone. It can be revisited over the years and, as your circumstances change, your portfolio can be adapted accordingly. By following a strategic real return investment plan LFP allows you, at any point in your life, to be aware of whether you are on track to achieving your retirement goals or not.
There are people who save their entire working life believing that they are saving towards a lavish retirement, only to get there and find out that they can only afford that lifestyle for a few years. Similarly, you might find someone who is saving too much towards their retirement and would actually be able to cut down on their monthly contributions and live a more comfortable life now.
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