A Basic Guide to Planning Financial Independence

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By Brian Johnson

Following a number of requests from readers over the last few weeks we are going to look at some simple ways to plan your retirement, or financial independence for those who say they will never retire.

It is never too late to start planning for your financial independence in later years. However, the sooner you tackle this, the easier it is to overcome the hurdles on the way to achieving your goals. Let’s look at the some basics which you need to consider.

There are four major key elements to making such a plan, which will enable you to consider the way forward with a master strategy.

How long must your portfolio last?

This, of course, will depend on when you actually plan to hang up your boots and take it easy. Once you decide on this we need to stab a guess at the realities of how long you will live. With medical science the way it is and improvements in healthcare standards it is going to be the norm to live to 100 in the not too distant future.

In any event if you make a plan to expire when you are say 90 and then you live well beyond that it could be disastrous! So, it is better to be conservative on this subject.

Income withdrawals, growth and inflation

We often talk about the effects of inflation, which are insidious, and which many expats simply refuse to acknowledge. I talk to some and they simply say there is no point to worry as they still think in Sterling or Dollar.

So to all those who believe the same level of income today will have the equivalent purchasing power in the future you need to get real.
An income of $50,000 today will require an equivalent of $110,000 in 20 years’ time to maintain the same purchasing power. If you had $50,000 today in cash and you put it in a drawer it would have the buying power of just $15,000 in 30 years from now.

Inflation is subtle and sneaks up on us over a number of years, and although we talk about annual rates of inflation and growth, these are actually moving averages. In some years markets will grow by 20% and in others they will lose 20%. Similarly although inflation has averaged 4% year on year for over eighty years now, some will remember the ‘good old seventies’ when inflation was running at around 18% in the western world. In summary it is never a steady rate.

If you were unlucky enough to lose 20% from your investments whilst drawing 10% as income you would need to make the residual assets grow by nearly 43% just to bring you back to par. So, it is going to be paramount that you do not rely on high growth rates for the years in which you will be drawing income.
Inflation, growth and required income are thus very important factors to consider.

A primary investment target

In order to ensure that you start along the right track you need to have a defined starting point, for instance the end goal in mind. It is essential that you are able to calculate your required income as you would require today, if you were to retire today, and then project this to your ultimate retirement age. Remember that inflation does not retire when you do and neither does it ever take a holiday. Just like a cancer it is always there ever growing. Thus you need to account for this by making sure that you have an income with the same purchasing power each year as you need in today’s terms.

Once you have calculated your required income and then projected the inflated value you will need to work out how much you need to have as a lump sum when you retire to ensure this lasts as long as you may live. This requires some tricky calculations because you will need to project inflation and growth rates as time goes on. So, advice from a professional is much needed here.

Remember to reduce the income you need by any arrangements which you already have in place. Do you have any pensions which will provide some income when you get to a specific age? If yes then take these into account in your projections.

It is almost impossible these days to accumulate sufficient assets which will generate an inflating income and leave your entire capital intact. Thus you will be wise to have sufficient assets at retirement but not such a high value that it makes the task impossible.

Objective investment strategies

Once you have an idea of the calculations you can look at the investment strategies which will enable you to achieve the target. It is also important that you set the strategies after that magical retirement date. This may require you to adjust the income you may draw and the length of time the assets will last.
The investment strategies you use before and after your retirement date will determine the asset mix to be employed. Common asset classes are equities, bonds, commodities and fixed interest. The greater the equity content you employ the higher the possibility of you achieving and maintaining your goals. On the flip side, the greater the equity exposure, the greater the chances of falling victim to the volatility which goes hand in hand with equities and which may produce heavy setbacks along the way.

Despite equities averaging 10% per annum returns over very long periods if you are unlucky enough to hit a bad spell at the wrong time your entire plan may be shredded. Had you been heavily into equities in 2008 you would still not quite have made back your losses and recovered your portfolio to par, some four years later. So, for those with a strategy in equities and planning their retirement in say 2011 disaster struck them when the recent recession driven market crashes were experienced four years ago.

All this requires tough thinking and a realistic logical hard look at your entire situation is required. If you become a pragmatist and project it as it is then you will be far more likely to achieve a genuine result.

The practicalities of creating a real plan for your retirement are essential. There are many of today’s readers who have neglected the facts and are suffering as a result. The younger you actually start the more likely it is that you will achieve the goals you need to set.

Much of the requirements today revolve around the fact that expats are left to their own devices when it comes to such planning. There are rarely employer plans in place such that you would enjoy at home. If you eventually return home you will have created a huge vacuum for the years you lost abroad living it up and neglecting your own financial future.

Think about it, take advantage of a third party review and then take the necessary action – now.