Time-Horizonld age with excellent financial independence is the ultimate goal of retirement planning. Whether you are in your twenties or the parent of a young adult, the process of ensuring that you have sufficient funds to maintain a desired standard of living through your ‘golden years’ is worth considering. Naturally, depending on an individual’s stage of life, the planning process will be different and contingent on one’s unique circumstances. Basic guidelines exist to help assist people in creating their retirement plans. These guidelines will either form the premise of a self-directed retirement investment strategy or can be used to help guide the investment process of an external financial professional.
Current age and expected retirement age helps to create one’s initial groundwork of planning a retirement strategy. Firstly, the longer the time-horizon between today and retirement, the higher the level of risk that one’s portfolio can withstand. The negative effects of return volatility are mitigated with a long-term time-horizon. Secondly, stretched periods of retirement portfolio accumulation must factor-in inflation. A 64-year old who is planning on retiring next year does not have the same concerns regarding inflation as a much younger professional who just entered the workforce. Thirdly, although it is typically advised to begin planning for retirement at a younger age, younger individuals are not expected to perform the same type of due diligence regarding retirement alternatives as someone who is in their mid-40s.
Finally, and most importantly, a longer time-horizon breaks up the overall retirement plan into multiple components. A multi-stage retirement plan must integrate various time-horizons along with the corresponding liquidity needs to determine the optimal allocation strategy. The future may seem far off, but now is the time to plan for it.
Having realistic expectations about post-retirement spending habits will define the required size of the retirement portfolio. Most people argue that after retirement their annual spending will amount to only 70-80% of what they spent previously. Such an assumption is often proved to be unrealistic, especially if they have outstanding mortgage balances. Since, by definition, a retiree is no longer at work for eight or more hours a day, they have more time to travel, go sightseeing, shopping and engaging in other expensive activities. Accurate retirement spending goals help in the planning process, as more spending in the future requires additional savings today.
Similar to the need to create a breakdown of multiple-time horizons, the time-specific spending needs must be determined as well. For example, a retired couple might determine that they will spend around GH¢50,000 per year on basic life expenses while alive; actuarial life tables are available to estimate the longevity rates of individuals and couples.
However, if the couple wants to purchase a home or fund their children’s education, those outlays have to be factored into the overall retirement plan. Establishing the regular and miscellaneous spending estimates at the beginning of the process should help in ensuring suitability of the portfolio allocation.
After-Tax Rate of Return
Once the expected time-horizons and spending requirements are determined, the after-tax rate of return must be calculated to assess feasibility of the portfolio producing the needed income. One of the biggest risks an individual can face is having their retirement portfolio depleted too early. This is referred to as longevity risk – the risk of living too long and thus outliving your investments.
A required rate of return in excess of 10% is normally an unrealistic expectation, as low-risk retirement portfolios are largely comprised of low-yielding fixed-income securities. A primary advantage of planning for retirement at an early age is that the portfolio can be grown to safeguard a realistic rate of return. Depending on the type of retirement account you hold, investment returns are typically taxed. Therefore, the actual rate-of-return must be calculated on an after-tax basis.
Whether it’s you or a professional fund manager that’s in charge of the investment decision, a proper portfolio allocation that balances the concerns of risk aversion and return objectives is arguably the most important step in retirement planning. A somewhat common segregated approach breaks down spending objectives into multiple allocation components.
‘Normal fashion’ has ranging definitions for different people. Although retirement portfolios are generally focused on either domestic blue chips or fixed incomes – depending on one’s risk tolerance – international investments and small caps may be included. The proportion between the assets will also vary from person to person, especially when the time-horizon until retirement is considered. Stable dividend-paying stocks are also popular for retirees, as these investments provide a consistent tax-efficient income stream.
Having a proper estate plan and life insurance coverage ensures that your assets are distributed in such a manner that your loved ones will not experience financial hardship following your demise. Despite that, estate and retirement planning are separate financial responsibilities requiring the expertise of experts in different fields; the two procedures must be considered in tandem with one another. In other words, a well-defined estate plan complements a thoroughly structured retirement plan.
A substantial retirement portfolio indicates a decreased demand for life insurance, yet a greater emphasis on vigilant estate planning. Because a large accumulation of financial assets can be passed on to the family of the deceased, the financial impact of funeral costs is mitigated with a hefty inheritance. However, if a parent wishes to leave assets to either their family members or even to charity, the tax implications of passing them through the estate process must be compared. A common retirement plan investment approach is based on producing returns which meet yearly inflation that is to adjusted living expenses while preserving the value of the portfolio; the portfolio is then transferred to beneficiaries of the deceased.
Retirement planning should be focused on the aforementioned steps: determining time-horizons, estimating spending requirements, calculating required after-tax returns, optimising portfolio allocation and estate planning. These steps provide general guidelines regarding the procedures required to improve your chances of achieving old age financial freedom. The answers to many of these questions will then dictate which type of retirement accounts (defined-benefit plan, defined contribution plan, tax-exempt, tax-deferred) are ideal for the chosen retirement strategy
One of the most challenging aspects of creating a comprehensive retirement plan lies in striking a balance between realistic return expectations and a desired standard of living. The best solution for this task would be to focus on creating a flexible portfolio that can be updated regularly to reflect changing market conditions and retirement objectives.
ABOUT OMEGA CAPITAL
Omega Capital Limited is an Investment management, private equity and investment advisory firm. The Company is authorised and regulated by the Securities and Exchange Commission of Ghana.
Nana Kumapremereh Nketiah (JP)
Omega Capital Research
The Alberts, 1st Floor
No. 23 Sunyani Avenue
Phone: +233 302 201538
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Additional information is available upon request. Information has been obtained from sources believed to be reliable but Omega Capital Limited (“Omega Capital” or “The Firm”) do not warrant its completeness, accuracy or veracity. The firm is licenced and regulated by the Securities and Exchange Commission of Ghana (SEC). This material is for information purposes only and it is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and estimates herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information.