Friday, April 3, 2009

How much is enough?

There are a few things you should be concerned about:
1) How much you need for regular expenses: traveling costs, wear and tear of your possessions, accommodation, food, entertainment, insurance premium, phone, VoIP or internet charges, etc.

2) How much you need if you run into unexpected health problems (aging, sickness, disability)

3) How much you need if you run into unexpected problems associated with traveling.

I think these vary along. For eg, if you travel by backpacking, sleep in 10-bedded hostel bunks, and minimize entertainment, then you could survive on US$30/day in most parts of the world for Area 1. Area 2 also depends on where you will be seeking medication or nursing care. Area 3 is usually well-covered by travel insurers. So, the easiest way to deal with 2 and 3 is to purchase the relevant insurance in your preferred countries of seeking medication, nursing or travel insurance claims. You may want to buy a backpacker's travel insurance from a UK, and a medical or Long-Term Care insurance from Thailand or Malaysia, for example. Insurance is the most straightforward means to deal with Areas 2 and 3.

Area 1 is what most people are clueless about. To ensure that you have US$30/day or around US$11,000/year for daily expenses and another US$1,000 for items like computers, clothes, water filter and shoes, you need a few sources of income that generate US$12,000/year adjusted for inflation. Supposed you have a fully paid annuity or rental property that pays you exactly this amount, then you have more certainty. You can have another source of income as a back-up for your annuity or rental income in case your tenant vacates your property or your US$12,000 annuity income shrinks in purchasing power over time. You may have a fund consisting of bonds and stocks for this back up, plus one year's budget reserve in cash (US$12,000 cash). But supposed you buy the financial planner's story that stocks and bonds are better than property or annuity in terms of yield, and ask how much should you have in stocks and bonds to generate this US$12,000/y, then you should aim at around
(100/3.5 x Annual Budget).
3.5% is considered a sustainable rate of return. But if you are retiring much younger, you can lower this to 3.0-3.3 to be safer.
For example, if you annual budget is US$12,000, and you are assuming a Safe Withdrawal Rate of 3.5%, then you should have (100/3.5 x US$12,000=US$342,857 in a fund that is invested 60% in stocks and 40% in bonds). For more details about SWR and how to withdraw from this US$342857 fund, google on SWR. Supposed you want to play safe, and assume only 3.0% return, then your fund needs to be (100/3 x US$12,000= US$400,000). So you should have a fund between US$343,000 to US$400,000 in stocks and bonds if you need US$12,000/y. This is a rough guide to how to calculate the money you need to retire today. And, of course, the returns is net of charges. So, if you invest in a fund with some annual management fees, you should take that into consideration.

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