Wealth is a relative concept. One person can derive great pleasure from a $3 coffee while another will experience electrical shocks of indignation if the champagne they’re presented isn’t from a certain region in France. When planning for a retirement tinged with affluence it pays to know the level of income that would satisfy you, the sacrifices you are willing to make today to attain that savings target and what risks you are prepared to take.
If you have enough time and know which tools to use, you can hit the target and retire rich – provided your definition of rich is within reach. The Association of Superannuation Funds of Australia says income of $57,665 will afford a couple a comfortable lifestyle in retirement (bear in mind this is tax free, and so represents a gross income of about $75,000). However, this figure includes a weekly food budget of $194.51 and a clothing budget of $58.30.
A couple retiring on income at this level is unlikely to be flying business class. However if you want enough to dine out on a whim, maintain multiple properties, enjoy luxurious holidays and update your car regularly you’ll need to aim much higher.
Start with the basics
Steven Eticott, accountant and financial adviser with CIA Tax, used this rule of thumb when estimating a retirement savings target: the lump sum needed for a couple to retire at age 55 is 17.5 times their desired income stream in retirement; 16 times for age 60; 14 times for 65, and; 11 times for 70.
Income in super is tax free, so the desired income stream should be viewed in relation to your take-home pay. If today you earn $100,000 and are happy to retire on an equivalent income, the income stream to be plugged into the formula would be roughly $75,000. You also need to allow for inflation.
Of course, the later in life you retire, the more likely you are to retire rich. Couples who want to retire next year at age 65 with an income of $250,000 a year will need to have saved about $3.5 million, according to Eticott’s rule (many readers will, of course, be perfectly comfortable with less).
Once you have a target, you need to figure out if your current level of savings will reach it, after factoring in contributions along the way. That is not easy to calculate as there are many variables: investment returns, inflation, the super guarantee rate and excess contributions, not to mention the sad fact that incomes generally start to drop away from the late 40s.
Get your head around risk
If the amount you are likely to reach falls short of what you’d like to live on, you need to ask yourself how you feel about taking on risk to chase growth. It’s a serious question, almost worthy of a session on a therapist’s couch.
Risk is a concept so often slung about in conversation but little understood. Simply, with investing, it means increasing your chance of gains or losses. You will get one or the other, and the outcome can be as unpredictable as flipping a coin.
“The main thing is to help individuals understand what it is they could afford to lose in their financial lives without upsetting their sense of self-worth and what it is they want to do, because from that you can calculate how much risk you need to take and how much you need to save,” says Paul Resnik, co-founder of investor risk tolerance consultancy FinaMetrica.
A low tolerance to risk can see goals evaporate if savers stampede for the exit when markets are hit in a downturn and place all remaining capital into low-risk assets and keep them there. “If you have a low risk of tolerance there’s a likelihood that when markets do the terrible things they do you’ll be panicked,” Resnik says. Portfolios can be down 20 to 30 per cent for anywhere up to five years, and that may happen more than once during an investor’s journey to retirement. During these times, it pays to invest in a down market. In Australia, the reduced tax treatment of superannuation makes it an obvious way to hit a retirement target, “and if you can supplement that along the way, all the better” he says.
Time line is money
Westpac financial planner Lisa Kirk explains three factors to help her clients understand how much risk they are willing to take: experience, education and time frame.
“The longer the time frame the lower the risk from volatile assets,” she says, “and that can make someone a little bit more comfortable.” By this she means investors who stick with a strategy are likely to achieve long-term average returns.
If they lose heart, they’re likely to miss the upturn. (If they caught the upturn and then cut out, they’re pretty smart or plain lucky.)
A negative experience tends to make savers more conservative, she says, citing clients who have watched their super balances stagger zombie-like throughout the global financial crisis. “But when people understand that shares and property have a longer time frame, they’re a lot more comfortable when they see it go down because they know it’s short term.”
Jeremy Chunn and Matthew Smith, Smart Investor, April 2014