I’ve always had an aversion to Maths. In analysing market performance I have always thought that formula gets in the way of a good story.
Bill, my mate, however, is full of sigma’s and china man’s hats and is over-the-moon that the CISI Wealth Management (WM) exam features their like, along with ratios of Messer’s Sharpe, Jensen, Traynor and others.
There is one thing in financial planning though, on which the story-teller and the pro-sigma school agree: the entirely negative effect of delaying your retirement planning.
The World Health Organisation (WHO) now puts the average lifespan at around 80 (more if you’re Japanese, less in parts of Africa). Assuming a working career from 21 to 65, we have 44 years to prepare a retirement pot that will have to last for at least 15 years. The CISI WM exam suggests assuming 20 years as the minimum necessary for the duration of a retirement pot.
If you are now 30 years of age, with no planning in place, then you now have around 35 years to plan for at least 20 years in retirement. And, bear in mind, that the WHO is highly likely to “tax” your age group further by upping life expectancy. All that gym and salads to blame.
So, today is all about warning of the cost-of-delay. There are two lines of thought, the first from the school of hard maths. Einstein said: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”.
“Playing hard” for the first three decades of life has an appeal. Fast cars, parties, golden cuff-links and expensive pots of moisturiser. Why not? After all, we still have another three decades of life to find the funding for - a now even later - retirement. However, the problem with this is: not only does interest compound, so does inflation.
The CISI Wealth Management syllabus illustrates the impact of delaying saving Stg100 per month for fifteen, rather than 20 years. The assumptions end with a difference of Stg17,200 per Stg100 of savings.
The second line of thought comes from the school “selling” pension products. The fund manager, Hansard, assumes six per cent grwoth an annum (fair enough) on ‘Accumulator Units’, which imply no charges (enough said).
Hansard tells us that a targeted return of Stg750 000 (change your base currency as you feel fit) would require Stg1,233 per month contributions. However, missing ten years of savings for the same benefit takes the saving rate up to Stg.2,794 per month. Missing 15 years of savings takes the monthly contributions up to Stg.4,903 per month.
For those NOT thinking ahead.... lets hope you stay healthy and enjoy your job!
How much do you need to retire?
Step 1: Work out in today’s values how much money you need to cover your lifestyle. Hopefully, you have the “roof-over-your-head” purchased, but don’t forget health care cover - the “new tax” for the current generation.
Step 2: Calculate what your employer’s pension will bring-in and add what you expect from your government - good luck with that.
Step 3: Calculate the short-fall. Let’s assume our shortfall is $20 000 per annum. Now take an assumed growth rate, noting todays risk free rate and “prudent” expansion assumptions. Lets take six per cent a year. The lump we need is 20,000 divided by 6 x 100, or $333,333.
Now add-in inflation. The two numbers you need are: the projected retirement age and an assumed rate of inflation. Government seems “happy” with three per cent, but with quantitative easing and expansionary fiscal policy, assuming four per cent inflation is more prudent. Lets also assume that you have 15 years until retirement. The calculation is: 1.04 (for inflation) x 15 years x 333,333, giving you the scary number around $600,000 for today’s equivalent of $20 000 per annum of purchasing power.