The problem most people have in planning for a comfortable retirement is, well, they don't plan.
Which is a shame, because a sensible plan is relatively straightforward to put together. And with just a small amount of discipline, a sensible plan — coupled with a sound investment strategy — can ensure you set yourself up for a comfortable retirement.
In fact, a very comfortable retirement.
Let me show you how. But first…
You Don't Need A Financial Planner
Having a plan is certainly better than having no plan at all, and for this reason a good financial planner can really help. Sadly though, perverse incentive schemes and investor apathy mean that many planners usually offer poor investment advice; and that can end up costing you a fortune in both fees and forgone investment opportunity.
There are three key reasons:
- Investment advice rarely strays beyond actively managed funds — which historically tend to underperform (sometimes significantly) the average returns of the market. This is largely due to fees and the fact performance is benchmarked on irrationally short time frames.
- Financial planners will often be incentivised to recommend products that offer them some kind of personal financial benefit, regardless of how well suited they are to you.
- The system reinforces misconceptions about risk; shares, we are told, are risky. Cash on the other hand, is 'risk free'. And that can lead people into making poor allocation decisions with their money. In truth, due to inflation and relatively low rates of return, cash is in fact a very risky proposition for the long term investor. Although shares may be volatile — that is, their prices can be erratic in the short term — they consistently prove to the superior investment option for the long term investor (as we'll see!)
And besides, it's not tough to make a sensible plan yourself. You won't pay any fees and even a novice can ensure they will probably achieve better returns than the average managed fund.
The Secret
There are three key ingredients to planning for a comfortable retirement:
- Spend less than what you earn
- Invest your savings sensibly
- Let time, and the power of compounding, work it's magic
It seems silly to emphasise the first point, but sadly it seems many people fail to put anything away for the future — at least enough to guarantee anything approaching a quality retirement. Remember, money makes money, so the more you save and invest today, the more you'll have at retirement.
Investing well is something that can certainly intimidate people. And when it comes to investing in the share market, it really can be a case of 'once bitten, twice shy'…
I'd advocate investing in a diversified mix of quality, established businesses with the capacity and intention to pay regular and attractive dividends — something we've helped thousands of members do with great success at Motley Fool Dividend Investor.
But even if you prefer to take a passive approach, a low cost index fund will ensure you essentially achieve the market average; you'll beat most active fund managers and you'll save a fortune in fees!
And the market average has proven to be very attractive over the years — about 11% p.a. (including dividends) over the past 30 years. That may not sound like much, but that makes it, by far, the best performing asset class.
And boy, does that really add up when you consider the third step in my path to a comfortable retirement: time.
According to Vanguard, $10,000 invested in the Australian Sharemarket (as measured by the All Ordinaries Accumulation Index) in April 1985 is today worth almost $240,000.
That's despite the 1987 crash, the recession of the 90's, the Asian financial crisis, the dot-com bubble and bust, 9/11, a few wars and the credit crunch and GFC.
The other line shows the performance of cash over the same period. You can see why it's such a risky long term investment option! The 'risk' averse investor has seen their $10,000 grow to less than $90,000 over the same period.
Bringing it all together
As impressive as the above chart is, it assumes that you make your investment and do nothing else. But as I said, regular saving and investing can make a huge difference, helping you to reach a comfortable retirement much sooner.
If we add a further $1,000 each year to our investment, which requires saving less than $20 per week, our investment today is instead worth almost $440,000. And as I said, the more you can save and invest, the better off you will be. For instance, had you started with a $20,000 investment and added $2,000 per year, you would today have about $875,000.
Again, these figures are based on the average return. If you can do better than average, which is certainly our goal at Motley Fool Dividend Investor, the numbers become even more impressive.
Interestingly, you don't need to do that much better than the average before you start to notice a very meaningful difference. If, by selecting your own investments, you were able to beat the market by just 1% p.a. on average, that $10,000 from our first example grows to nearly $310,000 — about $70,000 more than under an average return scenario.
As you can see, improving on any one of the three core principles of wealth creation — savings, returns and time — can make a massive difference to your standard of living in retirement. But when you manage to improve all three, the results become incredibly attractive.
That is, if you can save just a little bit more; if you can achieve a slightly better rate of return; and, if you can manage to start investing sooner, you'll find that a (very) comfortable retirement is much easier to achieve than you may think.
It just takes discipline, time and a sensible investing strategy
It Gets Better
Your goal of a comfortable retirement is made that much easier thanks to the benefits of superannuation. Contributions are taxed at a very low rate, and after you reach 'preservation age' — usually at 60 — your income is likely tax free.
Also, if you are invested in quality companies that pay fully franked dividends (where the Government assumes 30% tax has already been paid on your behalf by the company), you will be able to claim back those franking credits as cash!
For example, if you receive a $70 fully franked dividend, you'll actually get to pocket $100 once you claim back those lovely franking credits.
And if, by following those three principles of long term wealth creation, you have amassed a sufficient amount of capital, you can generate a very comfortable income in retirement without ever having to touch your nest egg.
Like I said, money makes money, and once you have a certain amount, you'll find that it throws off more than enough to fund a quality retirement. The capital remains untouched, and indeed, will in all likelihood continue to grow on average over time.
What you need
Ok, so finally we are at the business end of our discussion. Time to deliver on the promise of how you earn $60,000 per year, after tax, in retirement.
First, we need to make some assumptions. The most important, being the rate of return our investments can generate.
Unfortunately, it's impossible to know what the market will deliver in any given year. Although it is certain to vary greatly from one year to the next, it's safe to assume that the long term average will more or less be the same. Though the past 30 years has seen an average annual return of 11.1%, let's err on the side of caution and stick to 10% p.a. It's a nice round number.
Also, not all companies offer the same level of dividends, but an average will again serve our purposes. According to CommSec, the average yield on the ASX is 4.3%, but we'll assume 4% for our example. We'll also assume all dividends are fully franked — after all, that's what you are likely to focus on if you are in retirement.
Working backwards, if we want $60,000 after tax income from our Self Managed Super Fund (SMSF), and we are getting a 4% fully franked yield, we'd need a portfolio of $1,050,000.
If you are 10 years away from retirement, you'll need to invest about $405,000 today in order to reach your targeted amount.
You can however reduce that to $373,000 if you are able to save $100 each week and invest the savings at the end of each year. If you can save $200 per week, you'll need to invest $341,000 today to reach your goal.
Of course, there are a range of possibilities, but the following table may help as a rough guide:
Of course, those with 40 years until retirement will likely find it tough to save $200 per week, but then again they have a great deal of time to work with. Also, inflation becomes more of a consideration over longer time frames, so those at this end of the spectrum should seek to save and invest more than the minimum suggested.
For those that are near retirement, there is less time for the power of compounding to take hold, but at the same time there is likely more money with which to invest, and much greater savings power.
Foolish Takeaway
The goal of of $60,000 in after tax income in retirement isn't as farfetched as you might imagine — provided you have a sensible plan.
The scenarios sketched out here are of course just a guide, but should serve to help you determine how well you are placed to meet your goal.
Some people may wish to have a greater income in retirement, others may be content with less. Some may wish to take a more pro-active role in managing their investments, and target higher (yet still realistic) rates of return. You'll need to adjust things accordingly so that they make sense to you and your goals.
But in all cases, it just requires a bit of planning and the discipline to see it through.
Over to you.
