Do you know what you want out of life?
If that sounds like a surprisingly navel-focused question coming from a financial planner, it's only because - dare I say it - you probably haven't met the right financial planner yet.
Whether you do it for yourself or hire a professional to get you started, effective financial planning is the ultimate navel-gazing activity, albeit one with lots of numbers involved. "What do you want out of life" is the first question you have to answer, and the sooner you can answer it with certainty, the faster you'll get it, whatever "it" is.
|I know (precisely) what it is|
In my last post, I wrote about ignoring the "how much do I need to retire" question in favour of the "why" question. Today - although I just spent another 184 words on it because "why" is important - we're firmly back in the realm of real numbers ("Hooray!" shouted all of the money-nerds in the room.)
The second step to building a real (as in: not cookie-cutter) retirement plan is to figure out exactly how much you're spending and on what. If this sounds suspiciously like "budgeting", or "cash flow management" or "building a spending plan", that's because it is. The success of your financial plan - every single part of it, from retirement to debt elimination to insurance to investment strategy - is entirely, utterly dependent on how well you manage your income and expenses.
This is important enough that I want you to drop everything on your to-do list until it's done. There's nothing that can't wait for you to get your income and expenses analyzed, prioritized, and aligned with your goals.
(Shameless plug: if digging through a year's worth of transactions is something you can't find time to accomplish, it's something I'm very, very good at.)
And - for those of you about to skip this step because it seems like a lot of work and you already have a budget - if by "I already have a budget", you mean "I have a spreadsheet with amounts in it that I don't match to reality", or "I track my transactions in Mint but don't really look at the data", then I'm calling bullshit. Don't skip the next section, unless you want to continue to skip through life, ignorant of your potential, and only likely to reach your goals by accident.
How to figure out exactly what you're spending and on what (and what it has to do with retirement planning)
Step One: Pull out or download every single statement from every single bank account and credit card that you've used in the last year. If you use cash but haven't been keeping track of where, stop using cash.
Step Two: Start adding things up. Your fixed payments and recurring bills will be easy, so start with them. Anything you pay regularly should have its own category and running total, even if it's not a necessity. Move on to variable spending on necessities like groceries. You'll be left with an overwhelming list of transactions for things like clothes, entertainment, and eating out.
Step Three: Stop being overwhelmed. Figure out a sensible way to categorize your discretionary spending. By store? By type of purchase? I lump it all together, but that's because I've already done this exercise and am now in the "living by my budget so I can reach my goals" phase of life. Plus, it's a pitifully small amount at my house.
Step Three and a half: Realize that you're going to have to make some changes to your spending if you want to reach any of your goals, unless your goals include "working until I'm dead" and "never get to live the life I want". Today you're just adding things up, but later you're going to start subtracting, so take some time to get acquainted with the idea.
Step Four: Analyze. What will you have to spend money on when you're retired or reading on the porch as an independently wealthy forty-five year old? Will your mortgage be paid off? Will you still be driving frequently? Will you need life insurance? Will you spend more at Christmas? You're going to be older; will you have benefits at work to pay for your glasses and dental work? Presumably you won't be paying for diapers anymore, so you can strike those out of your budget with joy.
Your goal is to come up with the amount of money that will reasonably cover your expenses in retirement. This number can be expressed annually, monthly, weekly, or daily for all I care; frequency doesn't matter, and neither (at this point) does inflation. What matters is that your future expenses are based on real life, not on a statistically unlikely to be true "rule of thumb" that some back office analyst made up.
Okay, so you have a number. Finally. Now what?
Now that you know what your expenses will be, you get to think about how you're going to cover them. The next step in building a retirement plan that has a reasonable chance of success is figuring out where your income is going to come from.
This is part three of six posts about realistic retirement planning. If you're just starting with this one, the rest are here:
- RRSPs: Hunting Season (what banks and brokers are really offering at RRSP season)
- Avoiding the Useless Retirement Plan, Step One (figuring out what you mean by "retirement")
- Incoming (how to predict your retirement income from public and private pensions)
- Fun With Retirement Calculators (how to make the best use of a faulty tool)
- Effective Retirement Planning is About Spending, Not Saving (And Sit Up Straight) (what to do if you can't save enough)