Perhaps next to creating and maintaining a budget, financial planning for retirement may be one of the important things you can do for your financial future. We’ll explain financial planning, why we believe it’s so important, the steps you can take to create a retirement plan, and who can benefit from working with a financial professional.
What Is Financial Planning?
Financial planning is the process of looking at your entire financial picture, deciding on short, medium, and long-term goals (creating an emergency fund, buying a home, paying for your children’s educations, retiring). From there, you create a strategy that can involve debt repayment, saving, investing, tax, insurance, and estate planning to fund those goals.
Think of a financial plan as a map, or in more modern terms, GPS. You might be able to reach your destination without a map, but it could take much longer. Is it possible to reach your goals without a financial plan?
Financial Planning for Retirement
The earlier you start saving for retirement, the better, but it’s almost never too late. If you’re several decades from retirement, it can be hard to determine things like what age you want to retire or how much you’ll need for expenses each year. Luckily, there are some formulas and rules of thumb that can help you get ballpark numbers for things you can’t predict with certainty.
Determine Your Timeline
When do you think you’d like to retire? If you really enjoy your career, you might like to work well past the typical retirement age of 65. If you aren’t happy in your career or if your work involves a level of physicality that you can’t maintain for decades, you might want to retire well before 65.
Having some idea of when you want to retire helps you determine your risk tolerance when investing, generally your ratio of stocks to bonds—the further away from retirement, the more risk you can take.
Determine Your Retirement Number
Your retirement number is the amount of money you need to save before retirement. One method for calculating that number is the Multiply by 25 Rule. A good rule of thumb is that you’ll need 80% of your pre-retirement income. Here’s an example:
- $100,000 per year salary
- 80% of $100,000 is $80,000
- $80,000 x 25 is $2,000,000
So your retirement number is $2,000,000.
Determine Your Draw-Down Number
Your draw-down number is how much you can withdraw from your retirement savings each year. The 4% Rule can be used to calculate this amount. According to the 4% Rule, if you invest at least 50% of your portfolio in stocks and the rest in bonds, you can safely withdraw 4% per year for at least 30 years and never touch the principal.
The Rule was created by William Bengen, a retired financial advisor, in 1994 and tested against some of the worst markets in history. The results were always consistent; 4% was a safe draw-down rate.
Using our $2,000,000 figure above, withdrawing 4% of that per year would give you the $80,000 you determined you would need for your expenses each year.
Choose Your Investments
When investing for short or medium-term goals, you have a shorter time horizon than retirement investing. Your retirement investments have longer to weather market ups and downs, perhaps several decades depending on when you started. So you can take more risks with your retirement savings, but your portfolio should gradually become more conservative as you near retirement.
Who Needs a Financial Planner
Not everyone needs a financial planner, but most people could benefit from some level of financial planning advice. Those with more complex needs, business owners, high-net worth individuals, and those with complicated family situations (multiple spouses with children from each marriage, children with special needs, etc.) should seriously consider professional help.
The average lay person doesn’t understand the tax code and legal system well enough to create the kind of financial plan and estate plan needed for more complex situations.
