I am sure most of us are familiar with the concept of retirement planning. Financial institutions like banks, insurance companies and independent financial advisory firms have been promoting it to improve their business. Wherever you go to for your retirement planning needs, you will always get some standard textbook answers on this subject, which will result in commission income for these institutions.
In this article, I will run through these “textbook answers”, reveal their flaws and propose the true engineering solution to it.
Let us begin with the basic definition.
What is retirement?
All of us will have to retire unless we happen to die in our jobs. Retirement is a stage where we no longer do the jobs we used to do nor do we receive the salary we used to receive. Why do we retire? There are 2 basic reasons for people to retire:
1. Too old to work.
2. Too rich to work.
As you can see, the first case is the equivalent of being thrown out of your job while the second case is the situation of you throwing out your job. The objective of retirement planning is to ensure that we retire for the second reason. We retire because we become too rich to work and not because we become so old that our employer wants to get rid of us.
Now, that we have determined the reason for retirement, let us move on to the standard textbook answers on how to plan for retirement.
Standard textbook retirement planning.
Here are the basic steps on how to plan for retirement according to the standard textbook:
1. Determine the annual expenses needed to pay for your desired lifestyle after retirement.
2. Estimate the amount of years you are expected to live from your retirement onwards.
3. Multiply the annual expenses to the amount of years you are expected to live after retirement.
4. Factor in the expected rate of inflation from now until your retirement age.
5. The result is the retirement fund you need to build up in order to fund your ideal retirement.
6. Create a wealth building plan to build up that amount. This plan will invariably involve putting aside a portion of your current income to the recommended investment portfolio.
The above are the basic steps for the conventional retirement planning. They are available in every financial institution that is interested in making money out of this idea. Can you see the flaws in the above steps? Let me start by pointing out the obvious.
Flaws in the standard textbook retirement planning
Consider the last step, Step 6. How are you going to build up the amount for retirement derived in the above steps? You will probably be told that you need to invest regularly into a portfolio that will give you a certain percentage of annual growth. However, there is no guarantee in the estimated growth. Your advisor will not be liable if the recommended portfolio fails to achieve the targeted growth stated in the plan.
By the time you realize that your investment fails to achieve the target for retirement, it is too late for you. You will not going to retire in style. As for the financial planner who planned the failed investment, he or she will still be keeping the commission you paid from your investments. You need to be aware that financial planners get rich from the commissions from clients like you, not from their own investments. Their expertise is in persuading others to invest with them so that they can earn their commissions.
Financial planners are expert salesmen. They are not expert investors. So, if you choose to trust your financial planners with your life savings, you are heading for your own doom.
Next, let us assume that you can really achieve the targeted amount for your retirement. Let us assume some numbers here. Consider the following:
Based on your retirement planning, you need $5 million at age 60 to enjoy your desired retirement lifestyle for the next 30 years and you have successfully achieved the $5 million.
What is next? What are you going to do with that $5 million in your investment? Are you leaving the amount in the stock market? If you do that, you are exposing your retirement nest eggs vulnerable to the fluctuations of the stockmarket. Any market crash happens during your retirement will have the potential to cancel your retirement.
However, if you choose to liquidate your investments and keep the $5 million in your bank account, you are subjecting your retirement fund to inflation. No one can predict how high inflation can rise. When inflation becomes very high, you will lose a significant portion of your $5 million savings. Your retirement plan can still be cancelled.
What are you going to do? If you are thinking of withdrawing half into cash and leave the other half in investment, you will still face the risk in both sides.
So, the question is, how can such a bad plan become a standard textbook retirement plan? Who invented such a bad plan? Obviously that person cannot be an engineer. Engineers will never come out with such a toxic plan. Trusting a non-engineer for your financial future is very risky.
I believe that one of the main reason the global finance is in such a mess is the financial sector is run by non-engineers. Non-engineers should not be allow to be involved in the financial sector, let alone becoming financial advisors or planners.
Please note that I have nothing against non-engineers. I am sure most of the readers of this blog are not engineers. I have nothing against you. However, if we truly want to have a prosperous economic system and retire comfortably it is essential that we regulate the financial sector and only allow people with proper engineering background and training to manage it. In the end all of us, (engineers and non engineers) will benefit from a properly managed financial system.
There are many jobs that non-engineers can do but finance is not one of them.
At this point, I believe many will ask me what is the solution to the flawed retirement planning? Here is the answer.
Yeap Chee Seng’s engineering solution to retirement planning.
The engineering way toward retirement planning is to look at the retirement income and not the total amount. Instead of asking, “How much money do I need to save to retire?”, the engineering question is, “How much passive income I need in order to retire?”
The key word here is passive income. Passive income is defined as the income we receive without having to work for it. The clearest example is the income from rentals. If you have a property which you rent out, the rent will come to you every month without you having to work for it. If the amount of rents you receive is more than your total expenses, you are free to retire.
This means the correct way to plan for your retirement is to build up sources of passive income. In the above passage I use rental properties as an example but it is not the only source of passive income. There are many others, which I will cover in future posting.
How do you execute your retirement planning? This article is not meant to be exhaustive by itself. I can only give you some brief guidelines here. Maybe I will expound on this in future.
First, start your own research on the sources of passive income. The internet has many choices for us choose from. Then, make your move to build up your source of passive income. As you do, keep improving and enhancing your system. You have to keep reminding yourself that the real objective is regular passive income.
It will be helpful if the field you are involved in to be one of your hobbies or areas of interest. It is less tiring to do the things you like. Your hard work will not feel like hard work if you enjoy it.
Yes, it requires hard work. You have to do additional work after your regular paid job. In your paid job, you work to make your employer rich. It takes basic common sense to start working to make yourself rich by building up some sources of passive income to fund your retirement.
Is there an easier way? Of course there is. Give your money to the financial planner with no engineering background and hope for the best.
How about the target of my passive income? Your current income is a good guide. Let us assume that you own an internet business that gives you an income of 10% of your salary. What you have to do is either to increase the sales of your internet products by 10 times or set up 9 other internet businesses that gives the same result.
Once your passive income matches your earned income regularly, you are ready to retire anytime. You have to make sure that you don’t spend more than your passive income. At this stage, you can choose to resign if you want to. If you choose to keep on working, use your salary to build more asset base to create a bigger buffer in your financial fortress.
The result is financial independence the engineering way.