You may be thinking that it’s time to sit back and not to take risks in investment anymore. This situation is like the race between the tortoise and the rabbit. The tortoise was willing to race hard to get to the finishing line while the rabbit decided to take a rest and finally, did not reach the destination in time.
In money management, it is important to know where you are now compared to your financial goals. My experience tells me that many of us tend to underestimate the capital we need to support our desired retirement lifestyle. Table 1 shows the amount of capital required for different living standards upon retirement. Let’s assume that you are now 45, plan to retire at 55 and expect to live another 25 years. The inflation rate experienced is four per cent per annum throughout the period. Let’s also assume that you are experiencing an after-tax return on an investment of eight per cent per annum during the retirement period.
For those currently enjoying a living standard around RM180,000 per annum, it is reasonable to aim for a retirement living standard of RM120,000 per annum. If you would like to maintain a living standard of RM120,000 per annum, you would need a retirement capital of RM2,931,257 at 55, if the principal is to be liquidated over the next 25 years.
If you want to leave the real value of principal intact for the rest of your life, you would need RM4,791,123. Now, it is clear that RM1m-RM2m is insufficient to fund your required living standard if you plan to sit back and do nothing about it. In Table 2, the inflation rate experienced is six per cent per annum instead of four per cent as in Table 1 throughout the period of before and after retirement age. If you would like to maintain a living standard of RM120,000 per annum, you would need to have a retirement fund of RM4,335,053 at 55 if the principal is to be liquidated over the next 25 years. If you want to leave the real value of the principal intact for the rest of your life, you would need RM11,585,055. In another word, an increase of two per cent inflation rate will definitely make your retirement planning job even tougher. This situation is not so unlikely given the fact that things are getting more expensive everyday.
In Table 3, it is assumed that you are experiencing after-tax return on investment of four per cent instead of eight per cent per annum during retirement period. This scenario is not unlike that where you put all your retirement nest egg into fixed deposit to avoid losing the principal. In Table 3, you do not have a column for principal required to leave the real value of principal intact for the rest of your life. In the scenario where your inflation rate is higher than your after-tax return on investment, there is no way you can keep your principal intact because it would be continuously depleted by inflation.
If you would like to maintain a living standard of RM120,000 per annum, you would need a capital of RM6,950,228 if the capital is to be liquidated over the next 25 years. You may be asking why my calculation is different from what you used to understand. Most of us would have used the following formula to determine the amount required to maintain living standard. It is a simple and straight-forward formula to produce desired income without depleting the principal. Principal needed = Income required/Expected return on investment (in most cases, use fixed deposit interest) For example: RM120,000/4% = RM3,000,000 If we use this formula to calculate the amount required for RM120,000 income, we would only need RM3,000,000 based on the assumption that bank interest is four per cent. By the same logic, this amount would be able to generate an income of RM120,000 per annum continuously for the rest of your life without depleting the principal. In that case, the amount required would definitely be smaller if we are willing to deplete the capital. Why the difference? The answer is that this formula does not take into consideration the impact of inflation. Any calculation without inflation factor would not be realistic and therefore not accurate.
No matter how much you have accumulated so far, put some effort into objectively evaluating where you stand in your retirement goal achievement. Only when you know will you be able to take the necessary actions required to reach your destination. For details about how much you need for your retirement and to download a retirement capital calculation template, log on to www.yapminghui.com and click on Latest News section.
*Taken from NST Online
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