The best retirement funding plans rely on various sources of passive income. Consider this complementary approach for funding your later years.
Even with the effective elimination of GST in Malaysia from June 1, things are still expensive for many Malaysians. Almost all of us need to work hard at our jobs to earn enough money to get by; more of us should work even harder at planning for a great retirement.
We must take the discipline of lifelong investing seriously. If successful, we will have positioned ourselves to partake of the bounty within Earth’s integrated economy. That participation might help each of us enjoy a golden retirement instead of just scraping by in old age.
So how might we begin today in mid- 2018? For starters please mull over this scenario: For illustrative purposes, let’s say you wish to retire in two decades.
More specifically, if 20 years from now you hope to have RM5,000 in dividend inflows each month to augment any EPF or Private Retirement Scheme (PRS) derived income you might have then, that could mean you’ll have built a portfolio — of stocks or equity funds or preferably both — that generates RM60,000 a year for you in your first year of retirement.
Well, if the average dividend yield on your portfolio is 6 per cent, it would seem as though you should accumulate, over the next two decades, a portfolio worth RM1 million in mid-2038.
However, there’s a flaw in that logic because if you use up all of, say, 2038’s yield-inflow from your portfolio for living expenses in your first year of retirement, you will have no excess yield left over at the end of that first year in retirement for reinvestment.
But that excess reinvested yield from your portfolio will be needed to generate extra future growth from 2039 onward to help you stay ahead of inflation’s insidious wealth-eroding effects throughout your hopefully long, golden retirement.
Therefore, let’s assume you use for retirement expenses NOT ALL but only two-thirds of your average annual total yield. That’s four percentage points out of your target six per cent yield.
Your excess two percentage points can then be reinvested for compound growth aimed at compensating for inflation’s hidden erosion of purchasing power. So if just 4 per cent of your portfolio is supposed to churn out RM60,000 in usable income in your eventual first year of retirement, then you’ll need to build up that income-generating portfolio NOT to RM1 million but to RM1.5 million (60,000 / 0.04 = 1,500,000).
If we assume once you start building your portfolio it grows by a compounded average of 6 per cent a year in terms of total returns, meaning retained capital gains plus fully reinvested net dividends (for stocks) or reinvested net distributions (for unit trusts), then one way (out of infinite mathematical permutations) to reach your target in 20 years, would be, first, to set aside RM100,000 into your selected stock or dividend fund portfolio, and, second, to add about RM2,700 to it each month.
That combination of Initial Investment (II) of RM100,000 and Regular Monthly Investment (RMI) of RM2,700 into a portfolio which over the long haul averages 6 per cent compounded annualised growth will balloon to a little over RM1.5 million in 20 years.
Please whip out your financial calculator (if you have one) or work with your financial planner to verify my numbers, and then to rescale them — up or down — to your own specific retirement funding targets.
Remember RM1.5 million was the target amount we wished to reach before beginning to draw 4 per cent a year or RM5,000 a month in your first year of retirement, which I’ve assumed here will start in mid-2038.
You’ll notice the sums I have crunched will work well for any investment capable of generating 6 per cent, preferably more, a year. But because there’s an eventual need to draw ‘small’ amounts of money (RM5,000) at regular intervals (monthly) to fund a (hopefully) long retirement, your chosen investment vehicle shouldn’t be too lumpy or too illiquid. Ideally, it should be both highly liquid and reasonably safe.
IMPORTANCE OF PLANNING WELL
Well, in case you didn’t know, equities are usually liquid, and equity investment selection grows safer the deeper your analysis and the more intelligent your approach to diversification.
Therefore, I urge you today to consider (or reconsider) your retirement planning horizon. If it’s a long way off, be thankful; that gives you time to craft your own plan by yourself or, more practically, with the guidance of a trusted financial intermediary or reputable financial planner.
If, however, your retirement is near, you might consider working longer (hours and years) while also reallocating your existing retirement nest egg into income generating stocks and funds to better cope with, and to compensate for, future inflation.
Finally, remember to scale up or down from the numbers I have provided you with; you should do so based on whether you envisage needing more or less than RM5,000 a month in your first year of eventual retirement.
Next week we’ll take a break from this analysis to take a leisurely tour through human changes over millennia which have led us to this breath-taking point of being able to so richly partake of capi¬talism’s fruits in our 21st century.
Till then, happy planning!
© 2018 Rajen Devadason
Rajen Devadason, CFP, is a licensed financial planner, professional speaker and author. Read his free articles at www.FreeCool Articles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, rajen@RajenDevadason.com and Twitter @RajenDevadason