A Retirement Planning Calculator / Spreadsheet

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Putting it All Together


Retirement planning can be thought of as consisting of two phases:
  1. The accumulation phase -- saving for retirement
  2. The distribution phase -- living in retirement
In the previous two posts in this series, we looked first at establishing a target for the savings needed to cover expenses during the retirement years, and then at creating a savings plan to reach that target. In this post, we'll add some enhancements to our retirement planning Excel spreadsheet in order to create a consolidated accumulation and distribution plan -- we'll put it all together. This, in turn, will give us a foundation to do some additional analysis in future posts. (See the end of this post for a link to the spreadsheet.)

A Consolidated Retirement Accumulation & Distribution Plan



Retirement Planning: Graph showing retirement plan from Excel spreadsheet/calculator
Consolidated Retirement Saviings Accumulation & Distribution Plan

  1. The graph above (click on it to expand it) shows a retirement plan for a 35 year old, Alex, who hopes to retire at age 65 and live to age 90. Alex has no savings yet, but is planning to save 13 percent of salary from now on. Alex plans to put 3% of pay into taxable accounts and split the remaining 10% equally between a tax-deferred employer-sponsored 401k and a tax-free Roth account. (For a full description of this scenario, see the appendix at the very end of this post.)
  2. The graph shows the accumulation of savings up until age 65, followed by withdrawals. Withdrawals are assumed to be made first from the taxable account (light blue), then the tax-deferred 401k account (medium blue), and finally from the tax-free Roth account (dark blue). Note that the balance in the Roth account goes to zero before Alex is 90 years old. The bright red slice is an estimate of the additional savings Alex would need in order for the savings to last until age 90.

Start Planning Retirement Early


This graph suggests that, under reasonably conservative assumptions, saving 13% of your income may not generate enough retirement savings if you wait until age 35 to start. Note, however, that if Alex were lucky enough to have an employer who provided a pension and matched 401k contributions up to 3% of employee salary, the situation would be remarkably better. Waiting until age 67 and receiving full social security benefits would also make a significant difference. (Note: for more on the importance of getting an early start, see Start Investing When You're Young).

How to Use Basic Retirement Planning Calculators More Effectively


Simple, so-called "linear," calculators/spreadsheets like this one help to identify the fundamental inputs to retirement planning, and the basic calculations and issues involved. In fact, this is a modified version of the spreadsheet I developed to do my own retirement planning early in my career. However, they must be used with care. In particular, I think it is important to be conservative in your assumptions regarding stock market returns -- especially if you are near, or in, retirement. To understand why, see Don't Plan Retirement Assuming Average Stock Market Returns.

Source from http://observationsandnotes.blogspot.com

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How Much Money Will You Need To Retire?

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How much in savings will you need to retire? A lot -- even many of you who are among the vanishing breed of employees who have traditional defined benefit pension plans. In this post I will introduce a spreadsheet to help you estimate the amount you need to save. I'll also provide a simple rule of thumb for those who prefer a shortcut.

Retirement planning: Savings needed vs life expectancy graph


Retirement Savings Needed vs Life Expectancy
 
This series of posts will not only help you estimate how much you will need to save, and help you develop a plan to save that much, it will also help you understand the whys. Understanding the issues, and the assumptions that retirement planning software packages typically make will, I hope, decrease the chances that you will misinterpret or misuse their results; this, in turn, will increase the chances of your living the retirement of your dreams.

How Much Will You Need in Retirement Savings?

For many people, the biggest savings challenge they will face is saving for retirement. The chart above (click to expand) shows the estimated savings needed for a hypothetical 25 year old, Pat, planning to retire at age 65 with living expenses of about $45,000/year in today's dollars. (Note: the $45,000 is after tax spending, not income.  If you plan to spend less than that in retirement, or have a traditional pension, or your employer matches some or all of your savings, or are more optimistic than Pat regarding the future of social security, or you're older than 25, or you expect less than 3% inflation, you may need to accumulate much less in savings.)  The solid red lines assume Pat's investments are in taxable accounts; the blue dashed lines assume the investments are in tax-deferred accounts such as IRA or 401k accounts.

As you can see, Pat will need about $2 million to fund retirement expenses to age 85 if the investments are in taxable accounts -- somewhat more if the investments are in tax-deferred accounts. The downward slope of the curves reflects the fact that, as a rule, the fewer years remaining to live, the less money needed. For example, not surprisingly, Pat will need less in savings at age 75 than at age 65. The curves that end at age 100 illustrate the fact that it will take significantly more money to fund 35 years of retirement expenses than to fund 20 years.

Retirement Planner Assumptions

Maybe a better answer to "How much money do I need to retire?" is "It depends." The amount you will need to save depends on a surprising number of factors -- most of which are difficult or impossible to predict. Below is a table of the input data used (click to expand) to produce the above graph.

Retirement planning: Savings needed assumptions
Retirement Savings Needed Assumptions
Note: Click on the above screenshot to expand it. The link to download the spreadsheet is at the end of the post.

Most people are relatively comfortable estimating their retirement age and their expenses in retirement. At the other extreme, however, are critical inputs that you may find very difficult to estimate, and over which you may feel you have little or no control -- your return on investment, inflation, and life expectancy (a euphemism for when you will die). In between are other important variables that you may or may not feel comfortable estimating, such as social security, pension income and tax rates (see link below for help on estimating social security). In fact, the only input that you can likely provide with certainty is your current age.

Introducing Al's Simple Retirement Planning Calculator/Spreadsheet

The retirement planning calculator/spreadsheet introduced in this post is similar to other basic planners that you will find. (See the end of this post for links to download the spreadsheet.) A key thing to remember is that the results can only be as accurate as your input. As a result, the reality is there is no way to know exactly how much you will need to save. For starters, you'd have to know how long you are going to live! Even so, I found a simple planner like this useful -- especially early in my career.

Another problem with models like this one is how they handle return on investment (ROI). Simple models assume your ROI will be the same year after year. Keeping up with recent stock market performance in the news -- it should be clear that the real world doesn't work that way. Unfortunately, the fact that it doesn't has huge implications on retirement planning. In a future post, we'll explore ways to deal with these issues more effectively.

A Conservative Rule of Thumb for How Much You'll Need to Save

In the meantime, here's a shortcut that many find useful. A common rule of thumb that some financial planners recommend is the 4% withdrawal rate. Withdrawing 4% of the portfolio in the first year of retirement is a plan that should work for a broad range of retirees. It follows that, using this plan, you would need savings equal to 25 times what you plan to withdraw from savings in your first year of retirement. This is a more conservative approach, and generally recommends savings larger than those recommended by the simple models. (In Pat's case the recommended amount is $3-3.5 million.) This approach to estimating required savings is most helpful if you're in or very near retirement; otherwise, you may find it difficult to estimate how much you will need to withdraw.

Note that the same factors still determine your needs; you just don't get a chance to specify them. For example, you'll notice that nowhere do you specify your expected return on investment or life expectancy. The method gives you a reasonable target under a broad range of circumstances, but it's not magic. If you're planning to invest all your savings in Treasury Bills, retire at age 50 and live to 120, this method won't give you a reliable savings target.

Conclusion

Most people will require substantial amounts in savings in order to retire comfortably -- especially if they do not have a traditional "defined-benefit" pension. Saving such large amounts will require a long-term saving and investment plan. The good news is that accumulating this much money is probably easier than you think.  The next post will help you develop a saving plan by addressing the question What Percent of Your Salary Should You Save?
Source from http://observationsandnotes.blogspot.com

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What Percent of Your Salary Should You Save For Retirement?

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"What percent of my salary should I save?" is a frequently asked question -- especially early in one's career. People often ask the question implicitly assuming there is a standard, magic percentage of your pay that works for everyone. I think the most honest answer is "it depends." In this post, we'll add some additional capabilities to my retirement calculator so that you can understand what the answer depends on and use the calculator to determine a percentage that works for you. (The download link is at the end of the post.)

Pat's Retirement Savings Plan


Graph. What % (percent) of salary plan to save

In How Much Money Will You Need To Retire?, we looked at a hypothetical 25 year old, Pat, who wants to retire at age 65 and have $45,000/year in today's dollars for after-tax living expenses (not income) during a 20 year retirement. The retirement calculator introduced in that post estimated that Pat would need more than $2 million in tax-deferred funds at age 65! (See that post for a discussion of the assumptions made; you may need to accumulate considerably less -- especially if you're older than 25, or you expect to spend less than Pat, or you expect to have a pension, or....) The graph above (click to expand) suggests that by saving and investing 10% each year, this 25 year old could accumulate the needed retirement funds -- and then some; the final total is over $2.3 million.

Keys to Successful Retirement Saving


Three of the most important factors in reaching your retirement savings goals are:
  • How much you contribute,
  • When you start, and
  • How much your investments earn

Clearly, the greater the percentage of your income you save and, the more you are likely to end up with. The general consensus is that 10% is usually the minimum starting point. Many people find that as they get older they are able to contribute significantly more. (See link at bottom of post for a fascinating discussion of how much other people are saving.)

The longer your money is working, the more it is likely to earn. By starting early, Pat is allowing 40 years for "the magic of compounding" to do its thing. Had Pat waited until age 35 it would have been considerably more difficult. (See Start Investing When You're Young)

The greater your return on investment (ROI), the more you will accumulate. Pat is assuming an ROI of 8%, the default assumption of many retirement planning calculators. Note, however, that it is your actual, not your planned, returns that ultimately matter. Be realistic; some of the links at the end of the post may be helpful in that regard.

From the above we can see that the percent of your pay you need to save clearly depends upon, at a minimum, when you start, and how much you earn on your investments. Start early and earn a substantial return, and you won't have to contribute as much. Even in the best of circumstances, however, you'll likely need to save at least 10%.

The Impact of Inflation


In Pat's case, there is another important factor that makes it much easier to accumulate $2 million than you would expect -- inflation. We've assumed that Pat is making about $65,000 a year. The savings needed are more than 33 times Pat's current salary; that sounds like a lot. However, in 2049, if Pat's salary keeps up with the assumed inflation of 3% per year, Pat's salary will be over $200,000! As a result, when Pat retires, $2 million dollars may "only" be a little more than 10 years salary.

Al's Retirement Savings Planner Assumptions


Note: Click on the screenshot below to expand it. The link to download the spreadsheet is at the end of the post.

Retirement planning savings assumptions

In the previous post, we saw that the amount needed for retirement depends on a surprising number of factors. When basic retirement planners calculate your planned savings, the results depend on a similar number of factors. Above are the inputs used by this model. It follows that the percent of your income you'll need to save also depends on factors such as how much money you start with (do you have a trust fund from a rich uncle?), and what percent of your savings are being matched by your employer.

Observations About Simple Retirement Savings Models


Simple savings models make the same simplifying assumption about return on investment (ROI) as we made when calculating needed savings. That is, they assume you will earn a constant return year after year. However, the fact that it's an unrealistic assumption is less of a problem here. That's because, assuming you update your plan every year or two, your estimate of how much you will have at retirement will become increasingly accurate. That doesn't mean you'll like the results, but at least you'll have the opportunity to do something about it if your plan is diverging too far from your target. For example, you could increase your annual savings during the remaining years; or, you could defer retirement until you've met your target.

A note of caution. So far we're only talking about saving for retirement. Many of you will also have to deal with saving for other important goals -- for example, buying a house, or sending kids to college.

How Much Should I Save For Retirement: Conclusion


In order to have a reasonable chance for a comfortable retirement, most people will need to plan to save a large sum of money. It's not as difficult as you think. However, there is no magic percent of your salary that works for everyone. Start early and you may be able to get by with 10%; wait 'till your mid-30s and you may well need to stash away 15% or more.

Note, however, that how much you'll want to save depends first upon what your situation will be after you retire.  For example, how much do you plan to spend?  Will you have a pension and social security? Those questions are addressed in the first post in this series. Retirement tools like this Excel spreadsheet can not only help you figure out how much you'll need to save to support your desired lifestyle, but also help you devise a plan to save it. The next post in this series will help you put together a consolidated savings and spending plan.  Remember, the earlier you start planning the easier it will be, and the better your chances for a comfortable retirement.

Source from http://observationsandnotes.blogspot.com

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Investing in FOREX or investing in Stocks?

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So, you have the money to invest, but you don't know whether to buy Stocks or try something new, like FOREX for example.

Stocks

Before we describe what are the benefits of FOREX, lets remember what are Stocks. Stocks have been a popular investment for hundreds of years. Companies issue stocks to raise capital for expansion and new projects, and each share of the stock represents a partial ownership in the company. Basically speaking, when you buy stocks you invest in the company and in the market it is working in.

Hence, when the company does well and makes a profit, the value of the stocks rise and you can sell your shares for a profit or hold on to the stock for even more gain in the future. Sometimes companies will issue dividends – part of the profits that are distributed to share holders, another way for you to make a profit.

Stocks are traded on Stock exchanges. Most stocks are bought and sold through brokers (agents) who charge a commission or fee for this service. American stock exchanges include the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotation System (NASDAQ). Most stocks are only listed on one exchange, although large companies may have listings on several exchanges.

Stocks were traditionally seen as long-term investments. So-called 'blue chip' stocks - those having proven value over many years - may form the backbone of an investment portfolio. Short-term traders (Day traders) exist, but it is a relatively new phenomenon made possible with the advent of Internet trading. Day traders attempt to take advantage of large daily fluctuations in the market by buying and selling many times in one trading period. It is relatively risky and broker commissions charged on each transaction reduce any profits realized.

Stocks may sometimes be bought on Margin, meaning that the investor borrows money to buy the stocks. Margin rates are usually around 50% - the investor can borrow as much as half the value of the stock.

FOREX

The Foreign Exchange Market (FOREX) is quite different from the stock exchange. In contrast to the stock exchange, the FOREX is primarily a short-term market. Most traders enter and exit deals within a 24-hour period – sometimes within a few minutes. Many FOREX trades can be made in one day without building up a large brokerage fee because FOREX trades are commission free; hence, you keep all of your profit. Brokers earn money by setting a spread – the difference between asking and selling prices.

FOREX is the largest financial market in the world. It is handles transactions worth $1.5 trillion every day ($1,500,000,000,000). By comparison, all the American stock exchanges combined handle daily transactions worth about $100 billion ($100,000,000,000), 15 times smaller than FOREX. It is not located in any one location, but in the virtual space of the Internet. Trading markets are located world-wide and because of difference in time-zones trades can be made 24 hours a day, 5 days a week. Trading begins in Sydney, Australia on Monday morning (Sunday afternoon New York time) and continues non-stop until Friday afternoon New York time.

The huge volume of FOREX and its around the clock availability, means that it is one of the most liquid markets in the world. There is always a buyer and seller for any type of currency because the world economy relies on the movement of goods from country to country. Stock exchanges have more limited trading hours. While it is possible to trade on exchanges worldwide, each exchange is independent and operates for just 7 hours a day. There is no way to buy or sell a certain stock that is only traded on one stock exchange when that exchange is closed.

FOREX has even more advantages compares to Stocks: It is more predictable than stocks, it follows well established trends, it allows high leverage – typically 100:1 instead of 2:1 on the stock market; and it doesn't require a large investment – mini accounts as small as $250 can get you started in FOREX.

The big question is what is Best for you? Are you looking for a Day-Trading constant activity, with its advantages, or a long-term investment. Know the answer and you know the nature of your next investment.

 Source from http://www.howtoadvice.com

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Reasons to Invest Money

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For all those urgent reasons there are to invest maybe the most important be to broaden or increase our retirement fund for being our current life expectancy higher than before. Nowadays, investments are the foundation of our future financial level. Bad investments can bring us negative turnovers and therefore decrease our future possibilities. You are looking at two options for your money, the first you can spend it or save it and invest it. According to the Bureau of Economic Analysis,  personal savings of North Americans are very low comparing them to other developed countries. A low savings interest rate indicates that North American citizens are accumulating enough savings as to carry out successfully any emergency, and keep the life standard after retiring. Below you will find a list of why is it more important to save and invest than to spend.
  • People live longer than before and need more money to keep on living
  • Medical, educational, and insurance expenditures are still very high
  • The more one saves now the better his future in what having money to recycle refers to
  • By investing wisely you may better your life standards and increase your future wealth.
Without having to win the lottery you may accumulate an important retirement fund without having to dispose of great amounts of money. It is easier than what you can imagine. All that you need is time, money to deposit in regular periods of time and a return rate for your investments. The following arguments show how these three elements: time, money deposited and an investment rate interact in reaching your first million dollars.
For example:
  • An amount of US$231,377 invested during 30 years, at 5% annual interest rate, will have a future value of one million dollars.
  • If the return rate increases to 5 or 8%, the initial deposit will be reduced to US$99,377
  • A US$99,377 deposit invested over a thirty year period, at 8% annual interest, will have a future value of a million dollars
  • If you make regular deposits instead of investing a big amount , the sum of deposits will definitely decrease.
  • US$15,051 deposited each year during 30 years, at 5% per year, has a future value of US$1 million.
  • Earning a larger turnover reduces the annual deposit amounts.
  • US$8,827 deposited each year during 30 consecutive years, at 8% annual interest rate, also has a future value of US$1 million.
  • If you make monthly deposits instead of annual deposits the amount of each deposit will decrease more.
  • US$1,202 deposited each month during 30 consecutive years, at 5% annual interest rate, will result in US$1 million.
  • If you make weekly deposits instead of monthly ones the amounts will decrease even more
  • US$276 deposited weekly during 30 consecutive years, at  5% annual interest rate will also result in US$1 million in the future.
  • If the annual interest rate were increased from 5 to 8%, the weekly amount deposited would be the following:
  • US$154 invested each week at an annual interest rate during 30 consecutive years would render a future amount of US$1 million.
  • If we extend the investing period from 30 to 40 years and keep an annual interest rate of 8%, the weekly deposit would only be US$66.  
  • US$66 invested weekly, at 8% annual interest rate, during 40 consecutive years would be worth a million in the future.
From these varied options we arrive to the following conclusions:
  • When longer the period, bigger the effects of recycling, which reduces the single initial amount or the diversified deposit amounts.
  • While higher the turnover interest rate, higher will be the recycling effects, which reduces the initial amount or the diversified deposit amounts.
  • While longer the period and higher the interest rate lower will be the single initial amount or the diversified deposit amounts.
The key to a successful financial plan is to keep apart a larger amount of savings and invest it intelligently, by using a longer period of time. The turnover rate in investments should exceed the inflation rate and cover taxes as well as allow you to earn an amount that compensates the risks taken. Savings accounts, money at low interest rates and market accounts do not contribute significantly to future rate accumulation. While the highest rates come from stocks, bonds, and other types of investments in assets such as real estate. Nevertheless, these investments are not totally safe from risks, so one should try to understand what kind of risks are related to them before taking action. The lack of understanding as how stocks work makes the myopic point of view of investing in the stock market ( buying when the tendency to increase or selling when it tends to decrease) perpetuate. To understand the characteristics of each one of the different types of investment can or may help you determine which of them is the right one for your needs.

Source from http://www.beginnermoneyinvesting.com

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Stock Market Futures

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An operation with futures can be defined as a contract or agreement between two parts in which they commit to Exchange an asset, physical or financial, at an established price and at a future pre-established date at the signing of the resolution.
 
For the buyer, the contract of futures means the obligation of having to buy the underlying asset at a future price at the date of expire and for the salesman, it supposes the obligation to sell such underlying asset at the future price at the same date of expire.

In futures two positions distinguished themselves, in whose losses or profits will depend on the relation between the future price (agreed at the present) and the price of liquidation (price of the underlying asset at the market and on the date of expire):

Long position (buying):
  • If the future price is  < than the liquidation price, the buyer obtains a profit.
  • If the futures price is > than the liquidation price, the buyer has a loss.
Short position (selling):
  • If the futures price is > than the liquidation price, the salesman has a loss.
A key element on the contract of futures will be then the determination of the futures price. This will be calculated in base on the cash price of the underlying asset plus the net financial cost; financial cost that will mark the difference between today (day the contract is agreed) and the date of expire of the contract.

So then, it will depend on the underlying asset defined on the contract. As a way of example we present the case of the shares and the bonds.

Forward price of a share:
  • FW= PC (1 + ti)- d (1 + t’ I’)
  • Where  FW= forward price
  • PC= Cash quoting of the share
  • I  = Rate free of risk
  • D = Dividends paid before expiration
  • T= time until expiration
And it pays dividends during the contract period; the person who accorded on the futures contract will no perceive the dividends in question.

Before this situation, you will have to deduce its impact from the futures price. If this is not done, the cash operation would result more efficient than the future operation and everybody would buy in cash until this effect would dilute   (arbitrage operation).

Forward price of a bond without the intermediate coupon payment:
  • FW = (PC+ CC) (1 + it/360)- CCF)
  • Where  PC = Cash quoting of the bond
  • CC = Running coupon of the bond in t    (synonymous of the accumulated interests)
  • t = time till expiration
  • i = Free of risk type of interest corresponding to  t              
  • CCF = Running coupon the day of expiration of the forward
Forward price of a bond paid with an intermediate coupon:        

FW= (PC +CC) (1 + it/360)-CCF- CC’ (1 + I’ t’/360)
  • Where: CC’= Paid coupon in t’
  • T’   = time until the expiration since the payment of the coupon
  • I’   = Type of interest free of risk corresponding to t’   
In this case the intermediate coupon acts in the same way as with the payment of dividends of the shares. Those who have a future over a bond will not receive the coupon, so it must be discharged from the price.

Source from http://www.beginnermoneyinvesting.com

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Options, Call Options, Put Options and Writing Options

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This section focuses on options which are stocks derivative investments. A derivative security is a financial security that derives its value from another security. 

Stock derivatives as options and futures are securities that offer investors some of the benefits of stocks without having to own them. 

Future contracts will be discussed in the next section.

Options and how they work

An options contract gives the holder the right to buy or sell shares of a particular common stock at a predetermined price (strike price) at or before a specific date (expiration date). An option is a right not an obligation to buy or sell stocks at a specific price before or at expiration date.

The strike price is the price at which the option holder can buy or sell the stock. An option expires at its expiration date.
A stock option is a derivative security because its value depends on the underlying security which is the common stock of the company. For example, the value of an to buy or sell Intel stocks depends on the price of the stock in the market.

Another underlying securities, besides common stocks, for the options contract are stock indices, foreign currencies, US Government debt and commodities.

Options are negotiated in the Chicago Board Options Exchange (CBOE), the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), the Philadelphia Exchange (PHLX) and the Pacific Exchange (PSE). Options can also be negotiated in the over-the-counter (OTC) market.

Understanding how options contract work can provide you with additional tools that can be successfully used in volatile markets.

Options are used to speculate with the movement of future prices of stock, and to reduce the impact of volatility of the stock prices, in some aspects the options are similar to future contracts. One of these similarities is that option holders with small investments can control a great amount of money in stocks for a limited time. The risk of loss, however, is much less for option holders than for future holders.

An options contract gives the owner the right to buy or sell a specific number (generally 100) of common shares from a company within a period of time.

Source from http://www.beginnermoneyinvesting.com

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