In a previous post I explained the need to have a financial goal and for financial planning. Your most important and overriding financial goal is achieving financial independence. The when is up to you, either before retirement date or at retirement date, nothing can happen until you calculate this magic number. This was the first real wake up call for me and became my starting point. With this number I could create a personal financial plan
How to start creating a personal financial plan
Once I had calculated my amount required for retirement the first question was how I was going to get there. This forced me to consider my current spending situation, debt situation and haphazard approach to investing and saving.
Just by considering all of this and having to prioritise and create some order and direction from the chaos, I was creating a plan. The diagram above shows the central goal and then the sequence of the steps that I have to follow for my personal financial plan to achieve my goal.
I translated this onto a spreadsheet and created a detailed financial plan. Here I mapped out what I had to do year by year to get to my target. I had to consider inflation rate and possible investment returns. I had to consider different investment options and prioritisation. I had to learn how to do these calculations and consider different scenarios. It may not be perfect, but at least it was a start.
I did not know how to do it all or understand it all but that was fine. I was finally acknowledging it and tackling it. I was learning along the way and I am still learning along the way.
Review your current situation
To calculate your final retirement amount you must decide on your expenses and cost of living at retirement. To do so you need a good idea of your current expenses and budget. Looking at your current situation you must find saving opportunities and consider how to tackle and eliminate any debt. Then come up with some priorities and a strategy.
A major decision I made was that I wanted to become debt free first. I decided that I wanted the freedom this would give me. Without a good understanding of investments I knew I would get a guaranteed return of the interest rate that I was being charged. So I put all my resources and energy into killing the debt. The only investments I did start were TFSA (tax free savings account) accounts for my wife and I. I also wanted an education fund for my son.
With these priorities in mind I had some ideas forming in my head. I would reduce my expences as much as possible to free up cashlow and then use this cash to eliminate my debt as quickly as possible. See my detailed post on this strategy.
Setting up the plan
To setup the detailed personal financial plan I had to include all the different parts of my financial life. I had an old preservation fund, and RA, a pension fund and a provident fund, home loans and I wanted to start a TFSA and an education fund for my son.
Essentially I considered our total family income and current expenses. What were these going to be over the next 10 years? How much money could I plan to allocate to paying off debt and investing in TFSA. How long would this take? I played around with all these scenarios.
I also had to consider what the interest rate on my debt was. What was the inflation rate and how this could affect salaries in future. What investment returns should I use. These financial assumptions are difficult, the past doesn’t predict the future but using historical averages is still your best bet. For this reason I took a very conservative approach. I rather wanted a worst case scenario that turned out better than the other way around.
The Financial FreedomTarget
Lets assume that my calculations show that my retirement expenses will be R30000pm. The target FIRE date for me was 2028 as by then my son will be finished school. In 2016 when I did this it was 12 years away. At an inflation rate of 6% the R30000 pm will be worth R60 366 pm. The numbers I have here are an example and not exactly my numbers.
Now you can apply the 4% rule which is the same as the 300 rule. So multiply the monthly expenses by 300. (See my previous post for more on this rule)
R60 366 * 300 = R18 109 768
So my retirement target number that I need in 12 years time was R18 109 768. That is a ton of money! I couldn’t believe it. I also did this calculation via my pension fund provider online calculator and came to a similar number, so it was real!.
This amount of money would allow me to make a monthly withdrawl of R60 366 or less without decreasing the total. Assuming I retire at the end of 2028 the money will last until after I am 107 years old or 2078 as you can see in the graph below.
If you want to calculate your number then do the same calculation as I did or just check the table in my previous post.
So how are you going to reach this number? Well that’s where your financial plan come into play.
Creating my personal financial plan spreadsheet
Lets just recap how we got here. You have your main financial goal and also some smaller goals to help you get there. You know what your monthly expenses look like and you have made some adjustments there to free up some additional money. You also know your retirement target number.
Taking all this info I drew up my personal financial plan in the form of a spreadsheet. It consists of 3 sections. The 3 sections are financial assumptions, monthly budget and annual cumulative value.
This plan then calculates the estimate of my retirement number based on my assumptions and budget. That final estimate number is the red number in the bottom right hand corner. This plan is adjusted annually depending on how we did and what the future looks like. Lets look at it in detail.
Section 1: Inflation Rates and Investment Returns
In the first section are the current and forecasted financial assumptions that I used. The inflation rate, the interest on my debt and savings and an estimated investment return. These numbers can be quite contentious and personal because they do have a significant impact on the final number. I have used the maximum of the official forecasted inflation of 6%. Interest rate were my actual rates paid at the time.
The investment return is the most contentious. I calculated the JSE 20y return between 1995 to 2015 and it was 12%. I have used a more conservative 10% just to be safe. Subsequent to this came across inflation rates and investment returns from a fellow FIRE starter Stealthy Wealth, where he uses 15%. So I think I am quite safe with 10%.
In 2015 when I did this plan I could never have imagined the drastic changes happening in 2020 with interest rates and investment returns. As things change I can adjust these numbers based on current outlook.
Section 2: Monthly Budget
Section 2 is my budget estimate of what we can afford to pay to our various sources of debt and investments. I have included our company pension contributions and an old preservation fund that I had. In addition we have TFSA accounts, an education fund and savings for travel and replacing our cars. The emergency fund is also in there which I had not yet started at the time.
This is where I addressed some of my other goals. Becoming debt free, plan for buying a new car and an education fund.
Here you can see these goals reflected in reality. First was to pay off all debt and then start investing, this was planned for 2020 as you can see in the plan. Second was to start the TFSA accounts and an education fund. Third was savings for car replacements. All of these have been included.
Section 3: Annual cumulative value
The last section calculates the cumulative value using the assumptions and the budget amounts. This then all adds up and results in the final red number. On this plan that number is R 17 887 825. If you recall from earlier my target FIRE number calculated from the 4% rule is R 18 109 768. So I am short by R 221 943, close but not exactly there. Not a big problem as its not all exact and can be managed.
Stress test this financial plan
This plan can never be exact as there are so many variables. However it is my best estimate at the moment and I am very comfortable with it, let me tell you why.
I said that I want to be conservative rather than bullish, so my conservative assumptions are as follows:
- After the first 4 years of tracking I am still spot on target so I am confident that I can stick to it
- The investment returns are conservative at 10% and I have used only 60% of that for my pension and provident so some more fat in there.
- This plan assumes that we will get no income from 2029 onwards, but my wife will more than likely still be working. I should have side hustle income by then and I could work an extra year or two if need be.
Only downside I have not factored in tax, my estimates are an effective 10-20%, this could be offset by the above.
Tracking my personal financial plan progress
At the end of each year I can check each of the investments and compare them to my plan. The total is cumulative so I can calculate my total investment net worth and see if we are on track. Using this I can adjust and tweak my assumptions going forward and we can adjust our budget to stay on track.
It has now been five years since that first plan and my current plan is very similar, just slightly refined. I achieved my debt free goal in 2019 and have just started investing properly now in 2020.
You shouldn’t take any of this as advice, consult a professional financial advisor for that. This is merely what has worked for me and my experience, so what has your experience been? Do you have a plan and did you do it yourself?