This article first appeared on Dollarsandsense.sg
Retirement planning can appear to be a long and arduous task. Unless you are already in your 50s, retirement is a stage in life that seems far away. However, retirement isn’t as complex as we may make it out to be.
In fact, with one simple formula, the entire process of retirement planning can be explained.
Here is the formula. Finance students would recognise it.
FV = PV (1 + I) ^ N
Where, F = Future Value, PV = Present Value, I = Interest, N = Number of Years to Retirement
Let us explain how this formula applies to retirement planning.
FV = Future Value
Future value (FV) represents how much you want or need to have for retirement. The number is different for everyone, though we assume nobody would say no to having more.
The aim here is to have a goal. Such a goal would be determined by the lifestyle you aspire to have during retirement. For some, it could include being able to travel overseas regularly for holidays. Others may have simple aspirations such as picking up hobbies that do not require as much money.
How much you need for retirement will be the FV you work towards.
PV = Present Value
Your PV represents the amount of money that is currently being invested. These include your CPF monies, the investments you make in stocks, bonds and REITs, and the investment properties that you own (if any).
It does not include “assets” that do not earn you a return. For example, the home you are currently living in does not generate a return. Neither does your emergency saving, which is kept in the bank earning a low-interest rate.
I = Interest Rate
“I” refers to the expected interest returns from the investments you made. The higher the interest rate, the more risk you are taking.
Individuals who are risk adverse may prefer going for a lower number here. At the base level, we can expect to get at least 4%-5% per annum, which is obtainable from our CPF Special Account. If we want higher returns, we will need to take more risk such as through investing in the stock market.
N = Number of Years to Retirement
“N” is the number of years left before retirement. The large the value of N, the more years you have to compound your returns. The older you are, the lower N is likely to be.
Balancing The Equation
Planning your retirement is as simple as working out and balancing this equation.
You can start off with FV. Perhaps your goal is to accumulate $500,000 by the time you retire. Based on this equation, you will need to look into what’s your current PV, how much risk you are willing to take for your investments, and when you want to retire.
The equation has to be balanced. For example, you cannot expect to retire in 10 years with $500,000 when you currently only have $100,000 and are not willing to take risks beyond 5% per annum.
Managing Your Expectations
Even though it’s simplistic in nature. This formula is a way of clearly communicating the point of how we have to manage our retirement expectations. We cannot expect to have a high retirement amount if we do not make the effort to invest the money we have today, or take some risk for higher returns, and give it enough time to compound.
We can adjust the variables to suit our preference. If we are not willing to take more risk, we can adjust the years (N) till our retirement, or put in more money into our CPF Special Account today to increase the PV.
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