Chapter 1: Am I financially independent?
Michael and Jennifer look tired. They sit across the table from us, holding their financial documents. We pour a cup of coffee for everyone and prepare to have an open and honest conversation.
Michael looks over to Jennifer, then to us. "What I really want to know is, am I able to retire?"
And that's the important question thousands of New Zealanders are asking themselves each day. With their permission, we'd like to rephrase it slightly - "Am I financially independent?"
In other words, "Is work now optional?" And if not now, then when, and how?
That's the right question to ask... and an almost impossible question to answer.
Almost everyone wants an answer with three or less letters - "yes" or "no" - but the most appropriate answer any professional could provide is, "Let me look at what retirement means to you. You know - your lifestyle and longevity, the estate you'd like to leave your children and so on. Then I'll be able to tell you the probability that you can retire now, and achieve all that's important to you."
The key word there is 'probability'. Unfortunately, that's an 11 letter word! But it's an important word because it acknowledges that the future is not certain. All assets - cash, fixed interest, property and shares - may have greater or lower returns than anticipated.
Some advisers imply that they can predict the future. Other advisers embrace that the future is uncertain and we need to incorporate that uncertainty into our planning so we don't get caught out. We fall into the latter category.
Furthermore, given that most of us want to plan on a long retirement – say, 30 years or more - how can anyone know for certain what returns will be like 30 years from now? A lot can change in that time.
So turning the question "Am I able to retire?" into a question about probability, is the best way to answer it.
The reality is simple: if retirement to you means living on $120,000 per year plus government super, but a serious conversation with your adviser leads you to believe that isn't sustainable, you'd probably adjust your current lifestyle. Doing so would increase the probability of you being able to achieve your retirement goals.
Whatever the initial probability, we must always understand it's adaptable to change in two important ways – the performance of markets and, more importantly, our choices and behaviour.
So how do we calculate the probability that you're ready for retirement? It is the combination of the answers to our eight questions (see below) that define for you what 'financial independence' really means. We've never met two people with the same answers... ever. Retirement is very personal and very unique and thus, your retirement strategy must be personal as well.
How do we calculate the probability that you're ready for retirement?
We really need the following pieces of information as a minimum:
- When do you want to be financially independent?
- How long do you plan to be in retirement for?
- What amount of net spendable cash do you want per year?
- How much do you want to leave your heirs and beneficiaries?
- How much can you save per year between now and when you aim to be financially independent?
- What percentage of growth assets are you are willing to include in your portfolio?
- What is the current investment amount dedicated to becoming financially independent?
- What certainty would you like that your goal works out at least as well as you've planned on, if not better?
With the answers to these questions we can determine the probability that your retirement will be at least as good as you wish for, or even better. By 'even better' we simply mean that, as the years go on, you can take larger withdrawals than planned, leave your heirs a larger estate than planned, and so on.
Now we're well on the way to answering Michael's initial question, "What I really want to know is, am I able to retire?"
And, when the answer comes back to Michael and Jennifer, "The probability is only about 25% that you can retire now, and achieve everything you want in retirement", they both look at us blankly, as if to say, "Where do we go from here?"