Saul Klein, e-PRO Real Estate Educator San Diego, CA
December 30, 2009 12:39 PM
These are challenging times. The economy and the housing market are not conducive to long term thinking and retirement planning, but the lessons are essential none the less.
When you mention retirement to many people in the real estate business they will tell you that they "never want to retire." If selling real estate forever is your idea of a good time, then you are retired right now and you still need a reserve fund for those slow periods in the economic cycle so you can do "whatever you want to do, whenever you want to do it, with whomever you want to do it with."
One of the reasons so few people achieve Financial Freedom is that they fail to quantify their objectives. How can you get to where you want to go if you don’t know where it is? You must have a target. From there you can develop a planning horizon and a savings and investment strategy. In a previous article we discussed different funding objectives. Here, we will consider the big one, retirement. The methodology is the same for any of your specific funding objectives.
Consider that there are 3 primary methods of generating income:
1. You at work – slavery
2. Others working for you – slave owner
3. Your assets at work – Money is the best employee; money never sleeps, money never gets sick, money never takes a vacation.
Ultimately, you want the bulk of your income derived from this income generating method.
Your goal is less of 1 and 2 above and more of number 3
To arrive at this point in your life (some call this retirement), you must increase your net worth over your working career, saving what you can to get to a point where your financial needs are met by the money you have accumulated, suitably invested (suitability is a conversation for another time).
So how much money must you accumulate, and how do you accumulate what will no doubt be a substantial sum? Let’s tackle the amount first.
You begin by deciding how much money per month you require to maintain the standard of living you are looking forward to in retirement. You can change this number anytime you like, it is your retirement, but we need to start somewhere. Let’s assume that number is $6,000 per month (and that includes the state and federal income tax required).
$6,000 per month is an annual income of $72,000 per year.
Now let’s pick a conservative rate of return.5% (you can change this as well; if you can get more than 5%, you will need to accumulate less, but we must make some assumptions or we remain stuck in inaction).
The formula we use is one that is familiar to most real estate professionals:
Income = Principal x Rate ( x Time, Time being 1 year)
Our Financial Freedom Target is the amount of money invested (Principal) at 5% (Rate) resulting in $72,000 per year (Income).
Dividing $72,000 by 5% (.05) results in $1,440,000
To generate $72,000 in income from capital invested at 5%, you need to accumulate $1,440,000 over your working career. You must accumulate this money from the money you earn and from the money your invested money earns.
How is that possible you might ask? If you are like most people, there is too much month at the end of the money.
Simply stated you must:
1. Increase savings
2. Reduce taxes
3. Reduce luxuries (for the time being)
4. Live more efficiently (financially)
5. Make your invested dollars work harder
Of all the areas we consider in financial planning, effective month to month cash management can contribute most to your goal of increasing your net worth and gaining control over your financial affairs. It doesn’t matter how complex your financial situation is, it all boils down to this: you earn money on one hand and spend it on the other. What remains before investment spending is "gross cash flow." This is the amount you can manipulate to increase your net worth.
If you haven’t read Clauson’s "The Richest Man in Babylon," I highly recommend it. In it Clauson gives us the "Seven Cures of a Lean Purse."
1. 10% of all I earn is mine to keep. I will learn to live comfortably on 90% of my income.
2. Put my money to work earning more money, and that money to work in turn.
(Saul’s note: Invest it in assets that:
a. Increase in value
b. Earn income
c. Increase in value and earn income)
4. Guard my money from loss. Know about what I do. (Knowledge)
5. Own my house.
6. Provide in advance for my old age and the needs of my family.
7. Cultivate my own powers. Become wiser and more skilled.
Pay Yourself First
Pay the most important person in your life, you, first. You pay yourself 10% of what you earn before you pay anyone else. You then discipline yourself to live on the other 90%. Master this and you are on your way to Financial Freedom.
Financial Success Secret: Small amounts of money accumulated and compounded over long periods of time really add up. The real magic is time and consistency.
If you were to save 10% of your annual income for 16 years, earning an average of 16% compounded annually, you could replicate that income forever on the interest earned on the accumulated capital!
Of critical importance to achieving Financial Freedom is the magic of compound interest.
