Step 2 – Where do you want to go?
RECAP – What do we know?
Now that you know where you are financially, you can ask yourself, “Where do I want to be?” and “By when?” The difference between where you are today and where you want to be and in what time period, is important for the development of your personal strategy.
Assume a family spends $200,000 per year after tax and receives a pension income after tax of $40,000 each year. Therefore to be independently wealthy, their portfolio needs to generate an after tax income of $160,000 each year ($200,000 less $40,000). Based on a 4% after tax return assumption, they require a $4 million portfolio ($160,000 divided by 4%), to do this.
Or let’s assume you spend $100,000 per year after tax and you receive pensions that after tax equal $60,000 per year. Then your portfolio has to be $1 million in order for you not to require any further savings ($40,000 divided by 4% - the amount you require from your portfolio every year divided by 4%).
Using an after tax return of 4% each year on a portfolio is a good estimate for anyone. In real life what your portfolio makes will be different each year. And your after tax return will be influenced by how your portfolio is managed. However, it provides a good ball park estimate.
Let’s assume you want to save $25,000 for a down payment on a home and you hope to do this over the next three years, then your monthly savings need to be at least $695 per month ($25,000/36 months).
- With respect to how to invest these savings, please use conservative investment vehicles that will not vary in price over the period you are saving. For example, GICs at your bank or credit union, government savings bonds, savings account, treasury bills or money market funds.
- For those of you in this position, although your focus is on saving for your new home, put a small amount aside each month into your RRSP or TFSA. This can be any amount per month from $25 per month or higher.
When you are starting to save and until you reach approximately $5,000, consider using a balanced mutual fund to put the monthly savings into. To select the best mutual fund for you, I recommend you move to Step 3 to review and understand your personality as an investor and then move to Step 4 to learn how to select this fund.
- I would also recommend you continue to read so that you can begin to think about your plans for investing after you have bought your home as this process takes some time and thought. There is no time like the present to start to become informed.
If are saving for retirement, then I expect you need some conservative savings for a “rainy day” as well as a long term investment strategy for your assets that you are growing for your retirement. In this case, your annual savings need to be sufficient for near term needs like education for children or a larger home or a recreational home or a “rainy day” fund as well as funds long term investment strategy for your retirement.
It is really difficult to know how much you’ll need in retirement as life changes so often. So all you can do is your best every year based on what you do know. Therefore it is a good idea to have a ball park figure to save each year, work towards it and review this amount each and every year and revise accordingly. Again, it’s impossible to predict too far in the future so you just need to do the best you can for the information you know today.
The following link Retirement Portfolio spreadsheet will help determine what you need to save for retirement. Please note that this spreadsheet is intended to be as straight forward as possible. Thus it will not be perfect. For example, what you earn on your portfolio will be different each and every year and inflation may change dramatically. However, it is okay not to be perfect as what is important is that you try and save what you need. As I have mentioned above, a great deal will change between now and the time you retire – all we can do is our best to be in the ballpark. And at least if we are thinking about it and trying to meet our goals, we will be further ahead than if we do nothing or put “our head in the sand” out of fear of knowing. Again, like the other spreadsheets there is one for you to fill in and an example sheet.
(2) Then between their RRSPs (Canada) or IRAs/401K (USA), TFSAs (Canada), taxable investments and real estate investments they will need to grow a net worth excluding their home, of approximately a $1.5 million portfolio ($60,000 divided by 4%) based on today’s value.
a. Note that although I say excluding your home, if you do plan to downside your home in retirement, there may be money from the sale of your home that you do not require for the purchase of your “downsized” home. However, I would be careful on relying on this.
6. They must keep their investment strategy appropriate and not try to become too aggressive to make more money through the markets – as luck may have it, there may be a crash around the corner that could squash that plan and make things worse (more on this later).
Once you have determined what you need to save every year in the Retirement spreadsheet, go back to your Budget spreadsheet and see if there are adjustments you need to do to meet your annual savings retirement (or not!).