Here are the graphs, charts and images mentioned in the Plan Smart, Retire Right audiobook.
SIMPLE INTEREST VS. COMPOUND INTEREST
Compound interest has been called the 8th Wonder of the World – and deservedly so. By earning interest on interest as well as principal, your money grows much faster than it would otherwise. This effect is most noticeable over longer periods of time, when the magic of compounding can cause your total investment return to substantially increase from what it would be using simple interest.
Imagine you have received an inheritance of $50,000. You set this money aside as retirement savings, hoping that it will grow over time and help provide you with income once you retire. If you place these funds in an investment that grows at 8% simple interest (how much can you earn on the original amount you invested), the total amount you will have after 5 years is $70,000. If it grows at 8% interest, compounded yearly, the total amount is $73,466.
While the amount you earn with compound interest (the amount you earn from your initial investment in addition to the interest you earn, on top of the interest that has already accrued) is greater than with simple interest over this 5-year time period, the true impact of compound interest is best illustrated over longer periods of time. Let’s look at the same return scenario (8%), but over 30 years instead of 5; the difference is tremendous! At 8% simple interest, your funds grow to $170,000; while at 8% compound interest, they grow to $503,132!
RETIREMENT RISK MANAGEMENT MODEL
As stated in earlier chapters, I believe planning for retirement doesn’t have to be overly difficult. When meeting a potential client for the first time, I walk them through our Retirement Risk Management Model, which takes a more manageable approach to financial planning with a clear breakdown of identified steps. The purpose of this model is to show the client where our planning focus lies, and the steps needed to build a plan that can guide them to a worry-free retirement on their terms.
This process affords us the ability to examine income and expenses throughout retirement, potential gaps in protection and risk exposure, savings, investments, and what would be left to beneficiaries. With all of this in mind, I can better understand a client’s unique situation, and provide them with customized solutions that can be easily understood and implemented.
Core Income Funds
Core income is the foundation of your financial plan, covering all of your essentials and “must-haves”. These guaranteed income sources create lifetime monthly cash flow that is protected from fluctuations, corrections, or recessions in the markets, and continues, no matter what. They can consist of pensions, Social Security, income annuities, real estate, and high-quality bonds such as those issued by the U.S. Government. In Chapter 9, I will explain “green money” and core income planning in more detail to show you how to go about constructing additional lifetime income streams to generate more cash flow in retirement.
Contingency and Protection Planning
This is the level where you address things that could derail your retirement plan – such as an accident, disability, or long-term care situation. Planning of this type helps you think about and prepare for the unexpected.
By utilizing insurance products and other contingency planning strategies, you can better protect everything and everyone important to you from an unintended disaster. Taking the necessary protection and proper precautions enable you to secure your core income and ensure you and your loved ones are covered in an event the unexpected occurs.
Investments and Accumulation
This is the level at which you utilize various methods to grow and protect your wealth over time. An optimal and sustainable investment strategy takes into account both capital growth and wealth preservation. Offensive and defensive strategies in investing can be combined to foster the growth of wealth for retirement using a diversified approach that helps protect your assets from being too exposed to any one stock, market, or asset class.
Most people believe investing is risky. I believe investing can be risky if you lack the financial education or guidance to invest prudently. Ultimately, investing is one of the keys to financial freedom. If you take a measured and calculated approach to managing your investment portfolio, investing can help you live the life you want to live in retirement; whereas taking a reckless approach can certainly have the opposite effect.
Even though you spend all your working years accumulating wealth, many people spend just as many years in retirement. Proper planning and investment in retirement is critical, and learning how to invest correctly means learning how to make your money work for you. One of the biggest challenges in investing, especially in retirement, is making sure you have some type of risk management in place to protect your money in the case of crashes or market corrections. Make sure you don’t overemphasize growth in your retirement planning at the cost of exposing your quality of life in retirement to the whims of the market. I’ll discuss investment planning and accumulation later in Chapter 10.
Legacy Planning
Contrary to what many believe, legacy planning is not just a financial concept for the wealthy. In its simplest form, legacy planning has to do with strategies you can implement to ensure you maximize what you’ll leave to your kids, your beneficiaries, your favorite charity, etc. Legacy planning helps direct where your money goes when you pass away. Often, this can be accomplished with a carefully curated selection of insurance and financial products. Further, there are basic components to estate planning you should consider as well, such as a will, power of attorney, and health care proxy, to name a few. An attorney, or more specifically an estate attorney, can assist with properly preparing these items for you.
THE PURPOSE OF YOUR MONEY
In Chapter 2, we discussed accumulation vs. distribution, and the purpose of our money in these two distinct phases. I believe every dollar we have has a purpose, and understanding that purpose can help make sense of the money we have accumulated. When drawing up your retirement investment plan, building an integrated retirement income foundation is the key, and should help you create a more efficient overall retirement portfolio. You need a plan that can provide a stable source of reliable retirement income you can’t outlive. Your pension and Social Security may not provide sufficient income for this purpose, which is where your retirement investments come into play. I always recommend that my clients take inventory of their investments and savings, and split them into one of two categories based on their overall retirement goal:
Green “income” money – Making sure you generate enough monthly positive cash flow to live the lifestyle you want.
Red “risk” money – Making sure you optimize the rest of your money while consistently managing investment risk.
The difference between the amount of income you need in retirement to cover your expenses and maintain your lifestyle, and the amount supplied by reliable income sources such as a pension and Social Security, is what is commonly referred to as the retirement income gap. This gap is my first focus when it comes to determining what my clients need to secure for retirement. Some people rely on their long-term retirement investments, red “risk” money, to fill this gap once they retire. However, this approach can be dangerous because without the use of good planning software and sound strategy, it’s often difficult to determine how much of these funds you should use each year (depending on market gains or declines) while maintaining the discipline necessary to consistently allocate the correct amounts.
If it isn’t clear exactly how much income you should take from your investments and savings to fill the income gap in retirement, it may be tempting to take more than you should. If you consistently take more than sustainable amounts out of your investment funds, there may come a time when these funds are exhausted or are no longer able to generate enough money to fill your income gap.
A better approach may be to systematically calculate how much of your retirement funds are needed to be placed into income-producing products. One of the products I often recommend, helping to fill the income gap with more certainty, is an income annuity issued by an insurance company. With an income annuity, there is no risk of taking out too much or too little each year, or of running out of money, as income annuities pay out for as long as you live. These payouts are based on the claims-paying ability of the insurer, so I only work with A-rated, top-tier insurance companies to accomplish this. In Chapter 10, I’ll discuss the nuts and bolts of annuities in more detail.
GLOBAL ASSET ALLOCATION
In my opinion, red “risk” money should be diversified across a large variety of asset classes within many different markets and countries around the world. This can be accomplished by building a globally diversified portfolio through strategic asset allocation and proper diversification of your savings in the widest array of investment options. A globally diversified portfolio takes this one step further and spreads your money across as many global, non-correlated asset classes as possible. This can ensure your money is not subject to the same volatility as a portfolio that solely relies on U.S. equities or U.S. bonds. Here is a diagram of what we consider to be a global investment portfolio. Before you try to determine what percentage of your money should go where, it’s important to understand your goals, objectives and risk tolerance.
When the market experiences severe pullbacks, and other portfolios may be subject to bigger losses, a globally diversified portfolio, spread out over a number of different markets, can typically suffer less. This type of portfolio is not dependent upon one specific sector or asset class. The diversified plans I put together for my clients give them extreme confidence that not only should they be able to weather market storms, but they can actually come out ahead when all is said and done.
Outside this investment portfolio mix, there are other assets, like annuities, which can position some money with the potential to earn interest when the market is up, and de-risk with principal protection when the market is down. Adding annuities to a portfolio can help smooth out the long-term return pattern of a portfolio. It’s sort of like playing offense and defense at the same time. Later, I will discuss the different types of annuities one may wish to add to their retirement strategy.
Perhaps retooling your investment portfolio and taking advantage of all the available instruments in the marketplace can help you enjoy a more financially secure and comfortable retirement. Gone are the days when a portfolio of U.S. stocks and bonds, some international market exposure, and some alternative investments were enough to be considered “diversified.” Now, we can take diversification to the next level by combining a broad overlay across a variety of global asset classes with a non-traditional approach that offers a much deeper level of diversification.