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1992-08-15
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HOW MUCH WILL I REALLY NEED TO SAVE
FOR MY RETIREMENT?
(NOTE: This is an addendum to the SolveIt! (tm) 4.1 User's Guide. It
should be kept in the section titled "Some Relationships Between the
Routines". For the sake of simplicity, we will assume for this example
annual payments, that the investments are inflated by a constant 5% and that
the return is a constant 8%. You may actually select from any one of 8
payment periods and you can vary both the inflation rates and the rate of
return on the investments.)
From time to time, one of our technical support people will receive a
call from a user to ask if SolveIt! can solve this problem or that problem.
More often than not, such problems are complex in nature and actually
involve several financial questions. Yesterday, we received just such a
call. Our customer, a financial advisor who we shall call Ms. Silvers, had a
client Mr. Robert Wonderly, who was wondering about how he might plan for
his retirement. Ms. Silvers was of course very familiar with SolveIt! and
how to use the Payment Required Routine to calculate a savings plan that
will result in some final value 30 years in the future. But she wanted to
provide her client with a more sophisticated analysis of his needs. She
wanted to factor inflation into the calculations.
To illustrate, let's use the following scenario: Mr. Wonderly wants to
retire in 30 years on an income equivalent to $30,000 per year in today's
dollars. Once he retires, he wants his income to keep up with a projected
inflation rate. He also wants his income to last 20 years. The questions
are: What will be the equivalent value of $30,000 after 30 years of 5%
inflation? How much cash will be required at retirement to buy an annuity
that guarantees to provide this income? And how much will have to be saved
on a monthly bases to reach this projected amount?
SolveIt!, version 4.1, will easily handle this problem. First we
instruct Ms. Silvers to select from the Finance Menu the Purchasing Power
Routine. She enters $30,000 for the Present Value. Then key in 5% for the
assumed inflation rate for 30 years. By solving this problem Mr. Wonderly
will discover that it will take $129,658.27 to buy what $30,000 buys today.
The next step is to compute how much money is required to provide an
income that starts at $129,658 and then increases by 5% for 20 years. Assume
that the funds are invested at 8% compounded daily. To make this
computation, the Present Value of a Series Routine is used. (From the
Finance Menu select Present Value, then select Series.) Enter the following
values: for Payment Amount $129,658.27; for Total Periods 20; and for Annual
Rate 8%. Set the Payment Period to Annually and the Compounding Period to
Daily. Once these initial figures are keyed in, the Payment Amount needs to
be increased by the assumed inflation rate (5%). To do this, put the cursor
on the Payment Amount field and press <F10>. Select annual adjustment. Next
use SolveIt!'s copy feature to increase the payment amount by 5% for each of
the 20 years that you want the income to last. Exit the Enter Extra
Deposits/Payments window and press <F9> to calculate. The Present Value of
the series of payments is $1,808,705.
Therefore, Ms. Silvers concludes, it will be necessary for Mr.
Wonderly to have $1,808,705.12 invested at 8% compounded daily on the day of
his retirement to provide him with an annual income of $129,658.27 (the
amount equal to $30,000 after 30 years of inflation) that will be increased
to match an assumed inflation rate of 5%.
(This next step is not actually necessary to arrive at the amount that
must be saved to reach the target figure of 1.8 million. Rather this step
serves as a way for Ms Silvers to check her work (and the accuracy of
SolveIt!) up to this point.) From the Finance Menu, select Time to
Withdrawal. Enter the following values: for Present Value $1,808,705.12; for
Withdrawal Amount $129,658.27; for Inflation 5% and for Annual Rate 8%. The
date is automatically set to the current date. (It can be changed.) Set
Annuity Paid to Due; Payment Period to Annually; and Compounding Period to
Daily. Press <F9> to calculate. Note that this routine shows that
$1,808,705.12, when invested at 8% with daily compounding, will last exactly
20 years when an annual withdrawal is made starting at $129,658.27 and then
increasing annually by 5%. If Ms. Silvers wants to, she will be able to
print an Annuity Schedule to show her client how his income will grow.
There is still one step to perform to answer the truly important
question i.e. "What will Mr. Wonderly have to save on a monthly bases to
reach his goal?". From the Finance Menu, select the Required Payment
Routine. Once in the routine, enter the following values: For Future Value
$1,808,705.12; for Total Periods 360 and for Annual Rate 8%. Set the Payment
Period to Monthly and the Compounding Period to Daily. Again, press <F9> to
calculate. To reach the desired objective of having $1,808,705.12 on the
first day of retirement, Mr. Wonderly learns that $1,207.25 will have to be
saved monthly for 30 years assuming that the monies are invested at 8%.
Mr. Wonderly is taken back by the amount that he has to save. However,
Ms. Silvers points out that this is only an average amount that needs to be
saved over thirty years. And certainly, just as $30,000 will not have the
same value 30 years from now, neither will $1,200.
To help her client plan a course of action, Ms. Silvers turns to the
Future Value Routine. Using this routine, she is able to council Mr.
Wonderly that if he starts a savings plan today by making monthly deposits
of $350 and increases his rate of saving by 10% a year he will accumulate a
little more than his stated goal. To make her point, Ms. Silvers prints out
a future value schedule of a series of deposits being increased by 10% a
year invested at 8% for 30 years.
This is one example of how several of SolveIt's routines can be
effectively used together to do financial planning. The technique is simple
and straight forward. Break a problem down to a series of simple questions.
Select the appropriate routines, answer each question in the routine and
SolveIt! will compute the answer quickly with absolutely no programming at
any time.
Of course the procedure outlined here could be used to plan any future
purchase such as a college education.
****************
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