Thursday, April 4, 2013

Retirement Planning with Excel, Part 2: Making Ends Meet

If you're facing this:

Click image to enlarge

What can you do to improve your prospects? What can you do to improve the chances of meeting post-retirement expenses? Using the template that I provided in Part 1, let's see how much of an impact different strategies can make.

1. Save more

Who would have thought that a 32% savings rate (on a 30,000 per month budget) won't be enough for retirement? On the plus side, it turns out that a just bit more belt tightening, specifically saving around 2,000 per month more (or saving a total of 38% of annual income), will do the trick.

Lowering monthly expenses to 20,000 per month from 22,000

2. Earn more

If you feel that living strictly on 20,000 pesos per month (in today's peso) is unrealistic, then you would have to find a way to earn more. Fortunately, it won't take much to bridge the gap as increasing the annual salary growth from 4% to 5% will be more than enough. If a sustained, annual increase is not possible, then aim for one-time significant wage bump, like 20% at age 40, for example.

A one time wage increase to 51,000 per month at age 40

3. Don't be "too conservative" with investments

Changing the "Annual investment return" value in the template will show how sensitive retirement cash flows are to this variable. Keeping all your savings in a savings account which earns an annual return of 1% (nowadays, that's being generous), for example, will accelerate bankruptcy to age 70, and result in an end-of-horizon deficit of 26 million. Investing in still-safe but higher-yielding instruments like time deposits and T-bills will probably earn 2 to 3% per year; at 3%, bankruptcy is at age 73 and the shortfall is 24 million.

The "magic number" for annual investment return turns out to be 6% (keeping all other variables constant). Unfortunately, 6% per year after tax is not achievable with corporate bonds and bond funds alone, especially given today's interest rate environment. It's therefore important that you invest in "riskier" but higher-yielding assets like equity funds, especially while you're still young (and can afford to take on the additional risk).

Household scenario

But what if, like most people, you decide to settle down soon and raise a family. How would that affect your retirement planning? Using some assumptions from this past post about financial planning:
  • Get married in three years (and spend 600,000 pesos on the wedding)
  • Have and raise two kids, send them to good schools, and support them til they turn 25
  • Buy a new car every 10 years
  • Rent a house for 15,000 per month (at today's prices)
And assuming that your would-be wife is earning as much as you, your household cash flows and wealth will look like this:

Cash flows and wealth on a 60,000 peso monthly household income

As is, you'd be bankrupt at age 41 and would face a deficit of 100+ million at the end of the planning horizon. So please think very hard before you decide to get married on a 30,000 per month salary.

For the kind of lifestyle and decisions defined by the assumptions above, you would have to have a minimum monthly household income of around 100,000 pesos.

Cash flows and wealth on a 100,000 peso monthly household income

If you're not there yet, then you should make do with a more prosaic lifestyle. Or get a second job. Or stay single. Or something.

Hopefully, with this post you now have an idea how you can make ends meet.

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