In a recent article for the Wall Street Journal, Robert Frank examined some reasons behind the rise and fall of “the top one percent”. In the article, he cites a report by Maria Elena Lagomasino, who runs a wealth management firm in Palm Beach Gardens, Florida, in which she asks, “How is it possible that people who are on top of the heap can fall so precipitously?”
Three important factors include overspending, too much debt, and not properly diversifying investments. If you are within five years of retirement, use these cautions to create your own three part Financial New Year’s Resolution.
- Before you can project how much income you’ll need in retirement, you need to know how much you are currently spending. If you do not currently operate on a budget, create one to examine your cash flow. Set up a simple expense tracking system. For example, commit to using your checking account debit card for all spending over the course of a month. Then use the monthly statement to categorize and prioritize spending, considering which expenses will follow you into retirement.
- Examine your debt, and create a plan to eliminate it before retiring. First, get out of credit card debt. Next, take any remaining mortgage or other loans, and use an “amortizing loan calculator” to figure out how quickly you can pay off remaining debt. The answer is your new retirement date.
- Your investment focus will be shifting from building wealth to creating income, which requires proper diversification to manage risk. The circular nature of retirement planning involves a back and forth evaluation of your income needs and your portfolio’s ability to create it. As an example, if your retirement living expenses are $4,000 per month, and your Social Security and pension will make up $2,500 of that, your portfolio must make up the difference of $1,500. That is an annualized supplement if $18,000, which represents a 5% return on $360,000. The purpose here is to be realistic and prudent on an ongoing basis to ensure that you do not run out of money.
So in your reflections of 2011, and plans for 2012, consider what steps you can take to improve your finances, especially if retirement is on the horizon.