So how to plan successfully for your retirement? Below outlines the seven steps in designing a retirement plan.
Step 1 - Financial Discipline & Delay Gratification
Successful retirement planning always start with discipline cash management, before we even talk about any investment strategy. And this require the virtue of Delay Gratification.
Many people feel that they want to live life to the fullest. I do not disagree, but is it necessary to spend almost every dollar you earn, immediately in the same month, to live life to the fullest?
The number one reason for people to fail in achieving their retirement goal is the lack of financial discipline in delaying gratification. Delay gratification is an important virtue.
Your income is for the enjoyment of your lifestyle and life purpose, it has no other function. The important question is WHEN? How many percentage of your take home pay should be put aside specifically for the purpose of your retirement?
So how much are you willing to put aside each month for your retirement plan? Is it in line with how much you need to put aside?
Step 2 - Goal Setting
mortgage would be fully paid off by then, and whether your children would be fully independent by then.
Step 3 - Take stock of your current financial position
How does your current balance sheet looks? What are your assets, which are specifically earmarked for retirement, vs other objectives like buying a car, holiday or children education. Are you getting a fair return with the risk you are taking, for each of your existing investments? What about your liabilities, how soon can you pay them off?
Anyway to save interest cost on your existing liability?
Saving on interest income, through mortgage refinancing. If you have a substantial outstanding mortgage of $500k or more, and annual interest of 3.5% or more, you can potentially save over $10,000 interest in the first year alone, through refinancing of your home mortgage.
Step 4 - Understand your Risk Profile
** This is the step that most people (including many financial advisers), got it wrong.
It's a lot more then just investing based on risk profile, ie. if you have low risk tolerance, invest in low risk products, if you have high risk tolerance, invest in high risk products. That's what you hear all the time.
This is one of the most tricky areas that many people make mistake. Again, there is problem in both over exposure and under exposure to risk. Most people understand the problem of over exposure to risk, but what about under exposure?
The reluctance to take any risk, e.g. see any short term loss in capital, will result in reduction in long term growth in capital, directly impacting on the viability of your retirement goal. How to balance the two is both an art and a science.
First, you need to set a realistic expectation on the rate of return. Then, you'll need to construct an efficient portfolio that is in line with your required long term rate of return, investment horizon, at the same time taking you risk tolerance into consideration.
Your risk profile should take the following 3 aspects into consideration:
Step 5 - Gap Analysis
After a full review of your existing financial situation, and your retirement goal, it is time to do a gap analysis.
If you fall short, it's important to understand how much is reality deviating from your goal, and make plans to improve and/or accept the harsh reality.
That includes ensuring that you are able and willing to work past your ideal retirement age, or live with a substantial drop in post retirement lifestyle. Knowing the unpleasant reality and making mental, physical and financial preparation ahead of time will be a great help, than last minute surprises and shocks.
It is also important to determine whether you have other lump sum needs, near retirement?
Step 6 - Do not forget your Insurance
Retirement planning is not just about investment and making your money grow. It is also about protecting your money, to make sure they are there to fund your lifestyle. Without proper protection, your retirement fund may well be used to fund the doctor's retirement lifestyle (no insult to doctor, really).
The protection that are critical to protect your retirement funds are:
Medical insurance, this is critical, especially at old age. And you need to get it now, not when you are 60 years old, because chances are that you might not be insurable at that time, due to ill health like high blood pressure, which is every common these days.
Critical illness insurance, to offer lump sum payout to cover other outpatient medical cost that is not covered by a typical medical insurance, and also other of alternative treatment and some lifestyle adjustment cost.
Long Term Care. CPF Eldershield is such a plan, but at $400/month benefit, it is unlikely to be enough for most people.
It is therefore important to take a good review of your existing insurance plan and see whether they will work well for you during your retirement.
Step 7 (last step): Review your plan yearly or as needed
Yearly review is important to take care of changes change in:
1) Your goal 2) Your current financial situation 3) Investment return and portfolio management
Your financial adviser is mainly responsible to give you proper financial advice and develop the strategy. But obviously, you should be the one to take active interest and ownership in making sure that your plan will be successful, by doing review yearly.
It is your plan, not your adviser plan. So make sure you call him yearly for review. This is another common mistake that most people make. Because most people do not have a retirement plan properly done up, they just buy some investment products and then forget about it, without the slightest clue as to whether they are on track with regards to achieving their retirement goal.
Determine a realistic long term achievable rate of return based on:
1) your financial situation - balance sheet, cash flow, insurance adequacy, other dependency
2) your risk tolerance, your natural propensity to risk
3) your investment horizon, beyond your retirement
4) Construct an efficient portfolio taking into consideration of the above.