Most people assume that preparing for a time when active income stops can be safely postponed until middle age creeps up on them. They would be wrong.
When you’re young and everything is going your way, it’s difficult to think seriously about growing older and, more specifically, about retirement planning. That’s understandable, but dangerous.
If you’re fortunate enough to live a long, fruitful life, you’ll find the passing of years which turn into decades will take its toll on your ability to keep earning an active income from your job or self-run business. That’s why it’s wise to think about creating and then growing, as early as possible, passive income streams that pump cash into your life. We should make hay while the sun shines.
About half of all living Malaysians, me included, are fortunate enough to have EPF accounts that already do, or one day shall, provide anything between a sliver and a chunk of our retirement needs. But how much will we need each month in the future?
Doing the Maths
If you’re a 25-year-old working Malaysian with a RM3,000 gross salary, it’s possible you spend RM2,500 a month now. When the 2020s, 2030s, 2040s, 2050s and beyond roll around, you’ll need more and more money to survive and, ideally, thrive. Inflation, coupled with changing circumstances like getting married, having children, paying for their education and eventually forking out for your escalating health costs will balloon the amount you need to get by each year.
When I run similar analyses for my financial planning clients, a lot of time is spent on coming to grips with their specific milestones and lifestyle aspirations. Such number crunching helps me arrive at customised targets and savings rates for their retirement needs. For today’s column, though, I’ll keep things general so you may focus on the big picture of how much it may cost you to live later on.
As mentioned, I’ll assume you’re now 25 years old and spend RM2,500 each month. In the years ahead, inflation will have the biggest impact on your future regular cash needs, also called ‘your monthly cash burn’ or your burn rate.
If inflation rises by 3 per cent a year, you’ll need RM2,575 next year to enjoy the same lifestyle. If it goes up by 4 per cent, then you’ll need RM2,600. Those numbers are easy to calculate. What’s tough, though, is working out the long-term snowballing effects caused by many years of compounding inflation.
If you’re a whiz with Excel spreadsheets or a financial calculator, you can crunch your own numbers. But for lesser mortals who struggle with mathematics, the magical Rule of 72 exists to make life easier for us. This is how we use it:
Take 72 and divide it by the ‘raw number’ of any reasonable interest rate, say between 1 per cent and 20 per cent a year. If your annual inflation rate is 3 per cent, just work out 72 / 3, which equals 24. Similarly, if your inflation rate is 4 per cent, then 72 / 4 = 18.
Those two answers, 24 and 18 tell us the number of years it will take for us to reach the point in our future when we need TWICE as much money to buy the same quantum of goods and services, also termed ‘maintaining our lifestyle’.
Aspiring to improve
Most of us, however, don’t wish to maintain our lifestyle. We aspire to improve it year by year! This desired escalation in lifestyle tacks on a few percentage points to the appropriate inflation rate for our lives every year. So by way of illustration, if our long run national inflation rate is 3.6 per cent a year, and your specific desired escalation of lifestyle is 2.4 per cent a year, then your annual personal inflation rate = 3.6 per cent + 2.4 per cent = 6 per cent.
Then, using the Rule of 72, we find that you’ll need twice as much money in 12 years (= 72 / 6) to live the life you want in 2030.
So, if you’re 25 years old and spending RM2,500 a month in 2018, it is straightforward to work out, using our Rule of 72, that in 12 years (age 37 in 2030), you’ll need RM5,000 a month.
What is staggering to comprehend though is 12 years after that in 2042, you won’t be able to comfortably get by on RM5,000 + RM2,500 = RM7,500. No.
You’ll need twice your needed amount at age 37 at age 49, which is RM5,000 x 2 = RM10,000 a month! Then at 61, you’ll want RM20,000, and so on. The longer you live, the more money you’ll need unless you choose (or more likely are forced) to slash your lifestyle expectations.
Joy of dividends
Thankfully, as mentioned, EPF will help many of us pay for our old age expenses. But all of us are justified in hoping for more; to be able to revel in a golden retirement.
To do so, we should create passive income streams from our self-funded savings and investment portfolio. A great source for one such stream of passive income is dividends paid by robust listed companies. We may tap into such dividends through purchased shares in such companies or, more conveniently, when we buy a well-chosen dividend fund.
Next week we will consider how dividends from companies or distributions from a dividend fund may complement EPF or even a private retirement scheme (PRS) fund to supercharge our retirement income.
© 2018 Rajen Devadason
Read his free articles at www. FreeCoolArticles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, rajen@RajenDevadason.com and Twitter @RajenDevadason