It’s the big financial question: what’s your freedom figure? Or, to put it another way, how much money would you need to stop work and live well?
It’s the big question because a time of relative leisure is important in every life – and because no one wants to go into retirement fearful that the money will run out before they do.
Calculating your own freedom figure is difficult. This is not because the maths is complicated, but rather because there are several factors you need to decide and, often, compromise on.
• The amount you want to spend in retirement.
• The degree to which you may continue working.
• Whether or not you want to leave inheritances.
• The amount of capital that you have in lifestyle assets (your house, boat, and so on).
You must consider each of these variables. Clearly, someone who has an inexpensive lifestyle, a modest house, is prepared to do some paid work, and does not want to leave an inheritance will have a much lower freedom figure than someone who wants to spend heavily in retirement, live in a mansion, not work, and leave a lot of money for the family.
Each factor needs to be thought through, and should be tailored to what you want and what you can afford. Repeat the calculation process as you adjust and compromise on various factors to make the numbers work.
Step by step to freedom
Your freedom figure is the amount you’d need for a mortgage-free house, plus the investment capital required to fund your lifestyle above what you’ll receive from NZ Super and any ongoing work. Working out your freedom figure is a four-step process:
Do you have enough?
For example, if you have a mortgage-free house and retirement savings of $500,000, you should be able to draw $20,000 a year, based on the ‘Rule of 4 per cent’.
However, if after going through the budget process you find you need $30,000 a year more than the amount you’ll receive from NZ Super and/or work, your freedom figure will be a mortgage-free house and retirement savings of $750,000. That’s because if you draw 4 per cent a year from your $750,000, you’ll have income of $30,000 a year.
That means you need to save another $250,000 to have the life that you want in retirement – or perhaps you need to compromise in some other area instead, such as downsizing your house, or working more.
This is an exercise in decision-making. The compromises will be difficult, but no one can have everything. The key is to work out what’s most important to you.
The Rule of 4 per cent
This is a financial planning benchmark which says that in retirement you should to be able to draw
4 per cent a year from your investment capital. That means, for example, if you have an investment portfolio of $200,000, you can draw $8,000 a year.
The rule has three important assumptions:
• You draw 4 per cent from the portfolio each year and increase this amount over time with inflation.
• The funds are invested in a balanced portfolio, which means that 50 per cent of the portfolio is in shares and property, and 50 per cent is in bonds and cash.
• The fund will last for 30 years. You’re not solely drawing the investment returns; you’re also spending capital. That means that after 30 years, the investment capital will be gone.
First published 29 May, 2017
By Martin Hawes
Martin Hawes is the chairman of the Summer KiwiSaver Investment Committee. He is an Authorised Financial Advisor. A disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com. This article is of a general nature and is not personalised financial advice.
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