When plotting a course from any point in your life to retirement, there needs to be a plan. If you have no plan, how do you know if you are on track to reach whatever goals you wish to have? A plan lets you know if you are able to reach your goals, how close you are, and if you need to make any necessary changes, To create a plan, there are 3 major steps to include. Establish where you are today, what your goals are when you retire, and the path to get from today to retirement.
Step 1: Today
To create the plan, you need to have a starting point. You need to understand your current situation and what you have. Your current status includes, your assets such as cash, savings, investments, possessions, and anything of value that does not fall into the previous list. You can divide them into those categories as they will be identified as having a different benefit to your financial plan. Next, you need to list your liabilities or debts. These include all loans, credit cards, and anything in which you owe to somebody else. It can include money, services, or anything of value.
The plan should then identify your assets that can be used to off set your short term liabilities, such as credit cards and other short term loans. This will allow you to reduce those types of debt that usually carry a higher interest rate. By eliminating loans and debt with high interest rates, you allow yourself to keep those loans that may benefit you to keep. These are usually low interest, long term debts that can allow you to pay them off slowly and use the money you spend on other debts to be put into to short and intermediate term savings, as well as retirement investments.
Step 2: Retirement Goals
After you identify where you are today, you need to understand where you want to go. When you plan a trip across the country, you have a destination in mind. If you live in Los Angeles, and you want to go to New York, then you have set your goal. But, a part of that goal is to select a desired date. If you want to get to New York in 7 days, you will use a different means than if you want to get there in 1 day. Just like that trip, you will need different products to reach your goals. Another point to know is what kind of lifestyle do you want when you retire. Do you want to live the same lifestyle as you do now? Do you want to travel more? Relax more? Take up a new hobby? There are many things to consider when you make your retirement goals.
Some things to keep in mind when you create your list of goals, is to understand that inflation and taxation will affect the value of the money you need in the year you retire. $1million today will not buy what it will in 20-30 years from now. If you can live fine on $8,000 a month, you may need more than that to live in 30 years. Conversely, you will not have the debts and payments that you have today either. If you play your cards correctly, you may not have a mortgage, student loans, and kids to feed and clothe. So taking into account the future value of money and the understanding of what you will probably not be paying in expenses, you can come up with a number that you can live on and enjoy your retirement. Remember, as you go along, you will be revising your goals so you can get a better fit as you get close to actual retirement.
Step 3: Getting from Here to There
Now that you know where you are and where you are going, you need to plot out how you are going to get there. This is where the hard work comes in. This is where you get a professional to help you create this plan. First, you will need to calculate your disposable income (DI). This is the dollar amount you have left over from your paycheck and all other forms of income and subtract all your expenses. By knowing your DI, you can then take the steps necessary to eliminate your bad debt and increase your savings and investments.
Professionals have financial calculators that will show you how much you will need to save in order to have your goal reached. These calculations will take into consideration income, raises, inflation, investment return and goals. If you can afford the monthly amount it gives, then you are in good shape to start saving and planning what you will do in retirement. If you cannot afford the number, then you have some work to do to reduce your expenses and/or increase your income.
Expenses are required like utilities and taxes, are necessary like credit card payments and other things you need on a monthly basis to live comfortably, and there are expenses that are derived from wanting to enjoy things. The first you need to look at are those expenses that can be cut just by living a little lower than your income. A few less meals out, a few less trips to Las Vegas, a few less trips to the mall to buy the thing you can live without. As you revise your monthly budget, you will get a better idea of how realistic your goals are and if you need to push back retirement a few years or by lowering your lifestyle once in retirement.
As with that trip to New York, I mentioned, you cannot setup a plan and just go on auto-pilot. Maybe you want to visit the Grand Canyon, Texas, and Atlanta on the way. If you do, then you need to revise the plan. You need to do an annual analysis of the plan to see if you need to make adjustments. Maybe you got a raise, maybe you had a child, maybe you won the lottery. Change happens and by doing these reviews, you can make adjustments along the way and revise your goals if necessary. Who knows, your investments gave you a few good years, now you can move your retirement date up a year and increase your monthly income by $1000. Who know, but without a plan, you may never realize how close or far your retirement is.
Your financial professional will keep you updated on your plan and you will always be aware of if you will be retiring at 60 with a boat load of income, or having to wait until you are 73 and living with your kids. But, by waiting too long, you are just putting off that information until it is too late. The sooner you start saving, the better you will have in retirement and the sooner you realize how much you need to save, the better you will live between now and that date you set.