Journey Into Retirement

Retirement savings are a critical part of your financial security. Whatever expenses you cannot cover through Social Security, Pension, or post-retirement employment must be made up by your savings. The question as to whether you have enough money to retire is fundamentally a question about how long you savings will last – in other words how long you will be able to cover the expense gap left after you consider your other sources of income.

However, herein lies the rub. Retirement savings is a source of income that accumulates over time as you save through your working years. Let’s say that you are ten years away from retirement. How do you figure out what you savings will be when that magic day comes?

We need a way to forecast the balance from now until your planned retirement date. There are a couple of steps you can follow to do this:

1) First and foremost, you need to develop a spreadsheet that tracks the end of month savings balances for each of your retirement savings accounts. These monthly data points will allow you to establish a trend. The more individual months of data you have to do this, the better the forecast will be. I have been collecting end-of-month totals on my accounts since 2002. The more monthly data points that you have the better. If you have not been doing this for your accounts you need to start. I would not attempt a forecast with less than six monthly data periods and preferably 12 months or more. I go on-line and gather this information for my accounts on the day following the last day of each month.

2) Second, you need to determine what the trend has been. Another way of saying this is you need to calculate the growth rate over time. The technical metric I use is the compound annual growth rate (CAGR – pronounced Kegger, but it has nothing to do with beer). Hang on because I know that this sounds complicated, but help with this is to come.

3) Finally, the last step is to take the growth rate you calculated from the trends and use this to extrapolate your current savings balance to your proposed retirement date. How do you do this:

– You could line graph the data in your spreadsheet leaving the months from now until your retirement data blank in the graph. Then using a sophisticated statistical instrument such as a ruler, draw a straight line through the data and read the savings total where the line intersects your retirement month.

– However, there is a much better approach because the ruler technique misses one very important dynamic that you get when you save over time. That dynamic is called compounding and here’s how it works. Let’s say that at age 45 you have $100,000 in a saving account and that balance grows at a 10% annual rate. At the end of the year you would have gained an additional $10,000 ($100,000 x 10% growth rate = $10,000). Over time this savings balance should increase with help from the market and your contributions. Now fast-forward to age 60 and your balance has grown, for example to $650,000. That same 10% growth rate would yield $65,000 ($650,000 x 10% = $65,000). This is the magic of compounding and this dynamic is picked up in the CAGR calculation. You see, as your resources increase over time, the same growth rate will produce greater dollar gains. As you approach retirement, you may get a boost that you weren’t expecting. Of course, if the market crashes, it could work to your detriment as well – but, let’s keep a positive attitude here, shall we.

Now, I am betting that many of you are saying that you haven’t been collecting the end of month totals for your retirement savings account and even if you have been, forecasting sounds very complicated. To this, I would say two things:

1) You need to start collecting this information as a disciplined approach to managing your investments. I am offering you an approach to figure out what financial resources you will have to work with when you retire. However, without this data, it can’t be done. So, start with end of August data. After six months or a year you can begin to use the tool I am about to give you.

2) Next, look at the top of this blog page and you will see a tab labeled “Retirement Tools.” Click this tab and you will see a list of tools. Click on the tool labeled “Savings Forecaster” and this should automatically download to your PC. You will need to have a copy of Microsoft Excel for this to work. You can enter your monthly data into this tool and the forecasting is done for you automatically by clicking the buttons on the right-hand portion of the screen.

If you need help, you have a couple of options. If you have a Kindle or Kindle app on your I-Pad, you can download a copy of my book from Amazon (see the “Don’s most helpful book” blog tab – the book is $4.99 and is chocked full of useful information and links to other tools). The chapter on Income has detailed instructions on how to use and interpret the Savings Forecaster tool. If you don’t have a Kindle or I-Pad, provide your e-mail address in a blog comment and I will e-mail you a copy of the Income chapter.

The Savings Forecaster tool calculates and uses a variation of the compound annual growth rate (CAGR) and projects this forward to your retirement date. It incorporates compounding so it is markedly better than using a ruler. As I add new data to the Savings Forecaster each month, I reforecast. The more months you have in your data, the less volatile the forecast will be from month to month. Again, you need a decent string of monthly data for this to work correctly. However, the benefit is that you will not be flying blind when it comes to this important component of your retirement financial planning.