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Budget Details Income and Expenses
By: Paul Katzeff
Investors Business Daily, September 22, 2003
Whether you are rich or merely comfortable, you have to identify your financial goals and figure out whether you will have enough money when you need it.
Creating a household budget is a key tool in that planning process.
You can use it to chart your present income as well as calculate how much you need in the future, whether for retirement expenses or other goals, like buying a home.
Putting a budget onto paper helps you identify assets, income and expenditures that you might overlook if you try to do all the calculations in your head, says Patrick Horan, managing partner of Horan & Associates Financial Advisors in Baltimore.
BRAINSTORMING
If you confer with a financial planner, he can help you include sources of income or liabilities that will make a bottom line difference.
“A financial planner can ask questions that will help you identify important assets,” Horan said.
“He can help you include a variety of company benefits, employee stock options, restricted stock and nonqualified deferred compensation. He can also help you understand how they work. And he can show you what happens if you’re not with the company until retirement.”
Also, working with a written or printed version of your budget lets you make several versions. Each can use different assumptions.
You can base your calculations on a variety of growth rates for your investments, for instance.
And you can factor in rates of inflation ranging from low to high.
A budget makes it easier to see the relationship between time and money.
“The more time before you draw income from your accounts, the more conservative your rates-of-return assumptions can be,” Horan said. “Or the lower your annual contributions can be.”
The Internet is swarming with interactive calculators. (See table.) These help you calculate how large your nest egg must be after a specified period to generate the amount of income you want.
They’ll also help you figure out how much money you need to contribute each year to get there.
Calculators vary in their sophistication. Some do a better job than others in factoring in the impact of variables like inflation and taxes.
When figuring out how large your nest egg should be, remember that it will likely have to support you for many years beyond retirement, probably into your 80s.
“People live longer now than a generation ago,” Horan said.
As a result, your investments must include a heft helping of securities that grow. That means stocks and stock funds.
“Fixed-income securities, especially anything past three years (in maturity) right now, mean interest-rate suicide,” Horan said. “They carry too much interest-rate risk.”
Between low rates and falling prices, bonds and bond funds total returns risk lagging behind the rate of inflation, Horan says.
And while the official rate of inflation may still be relatively low, cost of living increases for real-world necessities can be alarmingly high.
EMPHASIZE GROWTH
Young families face college costs rising at 9.5% yearly, he says.
His own retired mother grapples with annual increases exceeding 8% in costs for housing, drugs and long-term care premiums.
“Equities are the place to be in the next three to five years,” Horan said. “With the new 15% tax rate on dividends and capital gains, equities give you growth as well as a tax advantage, especially in taxable accounts.”
Also bear in mind that your spending might rise in retirement.
“In the first 10 to 12 years, many of my clients travel, go on golf trips, do things,” Horan said. “There’s nothing wrong with that. They know you can’t take it with you.”
In those first dozen years of retirement, your annual spending may be 90% to 130% of your pre-retirement level, Horan says.
After that, it may drop to 60% to 80%.
So how big must your nest egg be?
Let’s say you are 55 years old and plan to retire at 65, with $100,000 yearly income.
Suppose your investments can grow an average of 8% a year. And let’s assume inflation is 3%.
Before as well as during retirement, that would let your nest egg gain a real 4.85% a year.
In 10 years you’ll need $1,323,004, Horan says.
“That will let you take out $100,000 at the start of each year,” Horan said. “After 20 years, your nets egg will be fun down to zero.”
To reach $1.32 million, you need $815,414 today.
“If you’ve got that much, you’re done saving,” Horan said.
If you’re starting from scratch, though, you must put aside $8,552 a month for 10 years.
If you already have $500,000, you need to save another $3,360 a month, he says.
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