I will try not to complicate the subject of savings and investing for retirement planning. Because it is a calculation which required estimation of future costs, we may need to use some analytical skills. But I will make sure that it is simple to understand.
When we say retirement planning (n term of money) we mean that we shall have enough by the time we retire. But the above definition is not complete, it is very important to define the term ‘enough’.
How much money is ‘enough’ for retirement planning?
Let us assume a person of thirty five (35) years of age, who needs $1000 for managing his monthly expenditures as on today. By the time he reached sixty (60) years of age he would like to retire. It means he has 25 years to manage his savings and investing for retirement planning.
A person who spends $1000 per month today will need approx $7000 dollars 25 years from now assuming a rate of inflation at the rate of 8% per annum. Inflation rate is the speed at which the prices rise in the market per year. So if the person wants to maintain the life style after retirement he will need to generate $7000 per month.
But there is a catch in the above calculation. It does not say for how long you will need $7000 per month. These days the life expectancy of people are rising comfortably to 75/80 years of age. But this is highly variable. People may live more than a general estimate. To be on the safer side let us assume 30 years. It means a person must have $7000 x (12months) x (30 years) = $2,520,000. But this is an exorbitant amount. A person who only needs $1000 to manage his expenditures why he may need to generate $2.5 million? Something is not right in the above assumption for sure. The mistake in the above assumption is not considering the ‘self-growing-power’ of money.
Bank Savings Account
It is true that a person will always keep their money in savings account (at least) and from there they may draw part amounts of $7000 per month. The money parked in savings account will earn an interest at the rate of 3.5% per annum. Suppose a person has $X in his account. After one year this $X will be $1.035X. Assuming that you are really able to generate $25,20,000 and keep this savings in bank then by interest alone (3.5%p.a) you will be able to generate $7350 each month. It means the principal amount of $25,20,000 remains untouched and you will be bale to make your living on interest. But assuming you are earning only $1000 a month, even if you save 100% of your earning, in 25 years you will be able to generate only $300,000.
Don’t get disheartened, there is a way out.
Decision one – Start savings and investing form today
This is the time where savings and investing are so helpful. Suppose a person who is earning $1000 per month decides to save 40% of his earnings. From day one he will use the strategy of savings and investing to ‘make his money ($400 /month) grow faster’. He decides to invest in stocks which will give his an average annualized return of 15% per annum. With $400/month and annualized return of 15% per annum, you will be able to muster $1,185,000 by the end of 25 years.
Decision two – After retirement invest you savings ($1,185,000) in a more lucrative investment option.
Now that you have invested for twenty five years in stocks and generated an average return of 15% per annum, you will find it east to invest in much safer investment options which give you at least 7% rate of return. Assuming that you invest in a debt linked mutual fund which will easily give you annual returns of 7% per annum. So with $1,185,00 you will be able to generate $7000 /month to manage your retirement with financial independence.
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