Imagine you are traveling by plane from Tripoli, on the coast of Libya, west to Cairo, Egypt. Suddenly your airplane crashes in the Sahara Desert. You miraculously survive. You take care of the immediate issues: provisions, shelter, and aid for the wounded. What do you do next?
I like to tell this story as a way to introduce people to the idea of creating a financial plan, but when I ask the question, “What do you do next?” I rarely get an answer. So what should you do next? Figure out where you are. You have to know your location. If Cairo is now north of you, what happens if you start out heading east? You’ll never reach your destination.
When you’re creating a financial plan, you need to answer the same question: Where are you? Where are you right now financially, and where do you want to go? What’s your goal for retirement, and how much money do you need in order to reach it?
Once you’ve figured out where you are, both with the desert survival and financial plans, you have to see if you have anything that can help you get to your destination. If you’re in the Sahara Desert, you should look for some sort of transportation vehicle. If you’re creating a financial plan, you need to consider all your potential sources of non-investment income. Are you going to get a pension? How much Social Security will you receive? Will your family give you any financial gifts? Once you have all the numbers in front of you, add them up.
The next step in creating a financial plan is to figure out your expenses. What will it cost you to live once you are retired? How much for groceries, for utilities, and property taxes? For insurance premiums? For just having fun? Add up all of your expenses (except income taxes). That total will be your expected cost of living.
Now subtract that cost of living number from the total sum of your non-investment income. If you end up with a positive number, you’re golden. Congratulations. You don’t even need any investments; you can live on what you have. On the other hand, if there’s a deficit (if your total is less than zero), you have to make up the difference. You need to create a financial plan that is designed to help you use savings and investment income to reach your retirement goal.
By figuring out where you are, where you want to be, and what resources you have, you should be able to reach your retirement destination-or maybe even cross the Sahara Desert.