Financial Planning: A Goal

What are you doing?

Financial planning is not about achieving unlimited wealth; to do that you need to create something. Go join a start up. Get into business for yourself.

Financial planning is about having enough money to do what you want, when you want. The key to financial planning is knowing what you need and when. For me this was one of the hardest things to do, but it is crucial. You may be in the same spot. If you can't answer the fundamental question of "how much when?" then you don't know how much to save, how much risk to take, or how much to spend. I hope that by telling you about the process I went through I can help you with your own analysis. Here's my story.

My Goal

My goal was to retire at a particular age and to maintain a certain lifestyle until I die. (I'm retired but not dead yet - so far it's working!) I didn't anticipate any extraordinary expenditures between my early planning and when I retired. I didn't have kids to send to college. I did not need to leave a large estate behind. In short, my plan was pretty simple.

Your goals may be much more complex. Kids to college? When? How much? Starting a business? When? How much? Buying a home? When? How much? Disabled sibling? How much each month?

Remember, every financial need you have can be reduced to two factors, "how much and when". Once you write that down, then you can plan. If you can't do this yet, read on and do it later.

What does it cost to live now?

When I started financial planning, I thought, "I like the life style I live today. I travel a lot. I buy toys that I like. I eat well (maybe too well)." If I could continue living like this after I retire I'd be pretty happy with life.

To find out what my life style costs I needed to know what I spend. For me, this was very easy. I used to keep my spending in Quicken and that had all the data I needed. If you use your credit cards and a debit card a lot, you may find that your banks provide a very nice itemized transaction report that you can download.

I created a report of all my expenditures in all categories, except: mortgage payments, savings, 401k, taxes, buying new investments. I included all the cash I took out of the ATM and categorized it as "miscellaneous expense." In essence, this is an accounting of all the money I blew maintaining my then current life style. That is $X per year.

I used to think that in retirement I'd need to generate as much income as what I currently made as a salary. But, when I actually totaled up what I spend, I realized that I save a good piece of my salary and I pay a huge chunk in taxes. When I added up what I really spend, it turned out to be a lot, lot, lot less than my salary.

I did not include money that goes into savings, 401k, or any other wealth-building category. I would not retire until I was sure I had enough accumulated wealth to live on. At that point, by definition, I would not need to accumulate any more wealth; the "expense" of contributing to various saving plans goes away.

I also didn't include taxes; post retirement taxes will be different - we'll add them in later. I also didn't include my mortgage payment. Sure I need to live somewhere. In fact I'd like to keep living in the same house when I retire. However, the calculations become easier if you add the mortgage in later. Trust me for now.

Most people think they need to maintain their current income level (or more) when they retire. If you have been a saver, then once you really think it through, you will probably find that the income you will need to have a very satisfying lifestyle is a whole lot less than the total salary you make today.

Write your $X here:
        I need this much money each year to live $________________

What will it cost to live retired?

I know that life will be different when I retire. I'll travel more, but for longer periods at a time. Funny thing is, a month in Paris is not much more expensive than a week in Paris. If I'm there a month I'll rent an apartment on the outskirts of town and ride the metro into the city each day after rush hour. Sure it will take longer to get to the d'Orsay than a $500 a night hotel in the Latin Quarter, but I'll be in Paris a month! What's the hurry? I'll eat at local bistros. I might cook a few dinners myself. I'll even get to know my neighbors.

I know that when I retire I'll cook a few more meals at home. I'll entertain more guests. It costs more to entertain, but it costs less to cook than to eat in restaurants. On the balance... Lots of things will be different when I retire. There's an exceptional book on this called, "Cashing In On The American Dream" by Paul Terhorst. It's currently out of print, but it's a great idea generator. You can probably find a copy in the used book market. (Also visit Paul's personal web site. Send him an email and he might even answer you.)

To keep up my life style I need $X a year. To dramatically improve it I would like to retire and still spend $X a year and have a nice place to live.

In the end, I decided that if I set a target income of 150% of $X I'd be in fat city. Let's call 150% of $X my new target: $Y.

Write your $Y here:
     I'd love to spend this amount each year in retirement $________________

And now the big question, how long does the party go on? I used to say that I could retire tomorrow if I started smoking four packs of cigarettes and drinking a quart of scotch a day. Instead I'm planning my finances to last until I'm 99. If the plan is for the money to last that long then I think the plan is certain to succeed. If I get to be a healthy 80 years old and the financial plan doesn't look as good, I'll stop traveling and start drinking.

Ah, your legacy . . .

If your goals are more complex, you can still figure it out. Say you have two children and you want to pay for their college educations and leave them a significant estate. How much does a good college education cost today? When do they go to college? How much, in today's dollars, do you want to leave to each in your estate? These things are not impossible to plan for, you just need to put them down on a timeline and answer two simple questions about each need: how much and when.

And just to be really rude about it, how do you compare these two options:

A) you work like a dog and put your kids through college and you leave them a sizeable estate when you die.

B) you retire at 50, your kids work part time while going to school and you spend a lot of time with your kids coaching them and giving them emotional support as they go into the working world.

There are a lot of scenario A) families out there with kids that never learn the meaning of money or how to adjust to real world economics. You might even know a few of your peers who were raised this way. There are innumerable stories of children who receive a good sized estate and then blow it all in a few years with expensive new cars, buying first class plane tickets, getting their own annual box at the local sports arena, or opening a restaurant ("because I've always wanted to own a restaurant").

I'll bet that under scenario B) your kids won't need a big estate from you - who knows, with your attentive coaching they might even retire earlier than you do! A great book about giving money to your kids is "The Millionaire Next Door". If you plan to leave money to your kids you should read this book. (Skip the tables and just read the fun stuff.)

Is home ownership in your plan?

In my case I now know that I need $Y per year in post retirement living expenses, but what about housing? If you don't own a home you might have a goal to buy one. Consider the down payment in terms of how much and when. Calculate what your yearly mortgage payments will be. Multiply your expected mortgage by 1.3 to account for taxes, repairs, insurance, etc. Add that to $Y and you have a new target.

If you already own a home, go back to Quicken and report on all your housing related expenses. Don't forget property taxes and miscellaneous repairs. Oh, and that money you've been saving to replace the roof? Count that too - roofs only last 25 years! Plumbing, dry rot, water damage in the bathroom, landscaping, painting. All of these things are expenses to you because you own the house you live in.

Write your yearly home cost here: _________________

Hmmm. As an option I looked at what it would cost me to rent a place like the home I'm buying today. Of course if I rent I'd be "pouring my rental money down the drain every month." Right. What I wouldn't be doing if I rented is burdening myself with monthly house payments and expenses on the theory that the house will appreciate in value, thus increasing my net worth. Remember, I won't retire until I have the net worth I need. There's no need to accumulate more wealth with that real estate investment, unless it's part of the overall financial plan.

Housing options

One reason I add housing in now is that it gives me some flexibility later to come back and redo the plan. It was hard for me at 40 to envision living a less grand lifestyle than was. Well, I can envision it, but I don't know if I could correctly judge how much less I would need to maintain that new life style. Housing options are easier for me to explore.

I know what a big house rents for in Gilroy - a lot less than a small apartment rents for in Saratoga. If I moved to Gilroy could I retire 10 years sooner? Or better put, would I be willing to move to Gilroy if it meant I could retire 10 years earlier? And it's not always as dramatic as Gilroy vs. Saratoga. There are lots of great locations that cost less per month to rent than buying the house I was living in. They aren't in downtown Saratoga, but they're not very far away either.

Would I be willing to live in a three bedroom, 1500 square foot rented executive condo in Campbell if it meant I could have 10 more retirement years? Hmmm, 10 years. That's a lot of time. I remember Jon once saying, "I'd buy my shirts at KMart if it meant I could retire early." Hmmm. If renting a home is the key to an early retirement then sign me up.

If these ideas are foreign to you then you'll probably think I'm nuts and skip these options for now. Once you've been on the financial planning treadmill for a few years you may want to come back and review all the assumptions you have made here.

Whatever options you chose, is up to you. At this point I have a target of $Y + yearly rent. Let's call this the final target: $Z per year. If I could spend this much every year I'd be living like a king.

Write your $Z here:
        I'd live like a king if I could spend this amount every year $___________

Step 2: A Little Math

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