Financial Analysis Example – Planning for Retirement

chart150x150

The first thing you’d want to do is make an organized list of assumptions. For this particular financial analysis example based on the narrative above, your assumptions list might look like this one:

Retirement Financial Analysis Example Assumptions:  
   
General:  
Birthday January 1
Today’s Date 1-Jan-10
Current Age 30
Start Date of Annual Retirement Savings Contribution 1-Jan-11
Age at First Contribution 31
Final Date of Annual Retirement Savings Contribution 1-Jan-44
Total Number of Annual Contributions 34
Age at Final Contribution 64
Retirement Date – Date of First Annual Withdrwal From Savings 1-Jan-45
Retirement Age 65
Years in Retirement – Total Number Of Withdrawls 20
Date of Final Annual Withdrawl from Savings 1-Jan-64
   
Financial / Economic:  
Annual Withdrawl Amount (In Today’s Dollars) $100,000
Average Inflation Rate Throughout Lifetime 4%
Annual Withdrawl Amount (In Next Year Dollars / Inflation Adjusted) — YEAR 0 $104,000
Nominal Rate of Return: Pre – Retirement  
                                       Phase 1 (Years 0 – 28) – Total 29 Contributions 10%
                                       Phase 2 (Years 29 – 33) 5%
Nominal Rate of Return: During Retirement  
                                       Phase 3 (Years 34 – 53) 5%

 

Next, you will have to convert your nominal rates of return to Real Rates of Return (inflation adjusted). Based on the assumptions above, you expect your real rates to be:

Financial Analysis Example Calculations:

Calculations   Notes (Spreadsheet Formulas)
       
Real Rate of Return – Pre-Retirement  
  Phase 1 5.7692% < — (((1+Phase1 Nominal Rate)/(1+Inflation Rate))-1)
  Phase 2 0.9615% < — (((1+Phase2 Nominal Rate)/(1+Inflation Rate))-1)
       
Real Rate of Return – During Retirement  
  Phase 3 0.9615% < — (((1+Phase3 Nominal Rate)/(1+Inflation Rate))-1)

 

Taking the calculations you have above, you can now work towards finding out how much in today’ s dollars you will need in total at retirement and subsequently what your yearly contributions will have to be in today’s dollars in order to meet your goals. In order to do that we need to know what kind of effect compounding has on the account.

When you are contributing money for a period of time without withdrawing any of it, the interest (or rate of return) your money earns will also earn money  for you over time. This is what compounding does. If that was a bit difficult to understand, consider the following:

You put $100 into a savings account that pays 5% interest annually. So at the end of the year your account will have $105. Since you decide not withdraw any of it, the following year you account will have the $105 + interest earned on the original $100 = $5 + interest earned on the $5 interest you earned the previous year = $.25. Therefore your ending balance  at the end of two years will be $110.25.

In our retirement financial analysis example, it’s a bit more complicated than the above, but the principle is the same. The effect of compounding needs to be quantified. The resulting number we will get is called the Future Value (FV) factor. The FV factor x Annual Contributions will equal the total dollars needed at retirement.

Let Z represent Annual Contributions

Z * (FV Factor)  = Total Dollars Needed At Retirement

Since we are interested in seeing contributions and future need in terms of  present value dollars, our future value factor needs to take that into consideration also. We normalize for this necessity by representing yearly contributions with a value of “1″ as its shown in column F below.

Financial Analysis Example Future Value Factor Calculations:

A B C D E F G H
               
        Future Value Factor
  Nominal   Real        
Year Rate of Return Inflation Rate Rate of Return Begin Balance Contribution ROI – (In Real Terms) Ending Balance Factor
      ((1+B)/(1+C))-1     (E+F)*D (E+F+G)
               
0 10% 4% 5.7692% 0 1 0.057692308 1.057692308
1 10% 4% 5.7692% 1.057692308 1 0.118713018 2.176405325
2 10% 4% 5.7692% 2.176405325 1 0.183254153 3.359659479
3 10% 4% 5.7692% 3.359659479 1 0.251518816 4.611178295
4 10% 4% 5.7692% 4.611178295 1 0.323721825 5.93490012
5 10% 4% 5.7692% 5.93490012 1 0.400090392 7.334990511
6 10% 4% 5.7692% 7.334990511 1 0.480864837 8.815855348
7 10% 4% 5.7692% 8.815855348 1 0.566299347 10.3821547
8 10% 4% 5.7692% 10.3821547 1 0.656662771 12.03881747
9 10% 4% 5.7692% 12.03881747 1 0.752239469 13.79105694
10 10% 4% 5.7692% 13.79105694 1 0.853330208 15.64438714
11 10% 4% 5.7692% 15.64438714 1 0.960253104 17.60464025
12 10% 4% 5.7692% 17.60464025 1 1.07334463 19.67798488
13 10% 4% 5.7692% 19.67798488 1 1.192960666 21.87094554
14 10% 4% 5.7692% 21.87094554 1 1.319477628 24.19042317
15 10% 4% 5.7692% 24.19042317 1 1.453293644 26.64371682
16 10% 4% 5.7692% 26.64371682 1 1.594829816 29.23854663
17 10% 4% 5.7692% 29.23854663 1 1.744531536 31.98307817
18 10% 4% 5.7692% 31.98307817 1 1.902869894 34.88594806
19 10% 4% 5.7692% 34.88594806 1 2.070343157 37.95629122
20 10% 4% 5.7692% 37.95629122 1 2.24747834 41.20376956
21 10% 4% 5.7692% 41.20376956 1 2.434832859 44.63860242
22 10% 4% 5.7692% 44.63860242 1 2.632996293 48.27159871
23 10% 4% 5.7692% 48.27159871 1 2.842592233 52.11419095
24 10% 4% 5.7692% 52.11419095 1 3.064280247 56.17847119
25 10% 4% 5.7692% 56.17847119 1 3.298757953 60.47722915
26 10% 4% 5.7692% 60.47722915 1 3.54676322 65.02399237
27 10% 4% 5.7692% 65.02399237 1 3.809076483 69.83306885
28 10% 4% 5.7692% 69.83306885 1 4.086523203 74.91959205
29 5% 4% 0.9615% 74.91959205 1 0.729996077 76.64958813
30 5% 4% 0.9615% 76.64958813 1 0.746630655 78.39621878
31 5% 4% 0.9615% 78.39621878 1 0.763425181 80.15964396
32 5% 4% 0.9615% 80.15964396 1 0.780381192 81.94002516
33 5% 4% 0.9615% 81.94002516 1 0.797500242

83.7375254

Completing this Future Value (FV) table gives a FV factor of  83.7375254.  So to revisit the formula, we now have: (continue reading)

CONTINUE READING >>>>> GO TO NEXT PAGE: 1 2 3

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>