Alfred Road has accumulated savings of $180,000, invested conservatively. The in

Question

Alfred Road has accumulated savings of $180,000, invested conservatively. The investment yields 9% interest. He also has $12,000 in a savings account at 5%, that he wants to keep for unexpected emergencies. His basic living expenses now average $1,500 a month, and he plans to spend $500 per month to travel and for hobbies. To maintain this planned living he will have to rely on his portfolio which provides $16,200 annually or $1350 monthly. Mr Road will also receive $750 per month in Social security payments for the rest of his life. Mr Road

Explanation / Answer

Mr. Roads is well-set with his financial plan, even with inflation higher than forecast. There are 3 questions here: 1. does he have enough to afford $2,000 per month with inflation at 4% -- assuming that he doesn?t touch savings or his house but can use the core portfolio? 2. what spending level would he have if the core $180,000 is untouched (at 4% inflation)? 3. how much could he spend each year if the portfolio goes to zero in at his 90th birthday? These are all forms of Net Present Value calculations, including the annuity that he would enjoy from the portfolio (#3). Now here?s the key data: ? Social Security is indexed and will provide a real annual return of $9,000, no matter what the inflation rate will be. ? Mr. Roads real concern is what happens to income & expenses with the other $1,250 per month ($15,000 per year). ? He has a portfolio (9%) and a savings account (5%) to produce the other $15,000 per year. So let?s proceed to answer the questions: 1. Year 1 he has portfolio and savings to try to get the needed $1,250 which is not provided by Social Security: Income = $16,200 + $600 = $16,800 Expenses: $15,000 Added savings: $1,800 In year 2, savings increase but expenses increase faster: Income = $16,200 + (.05) * $13,800 = $16,890 Expenses = $15,00- * 1.04 = $15,600 Added savings are down = $1,290 It?s easier to iterative work like this with a spreadsheet: ?Alfred Roads Annual Financials? http://www.mooneyevents.com/aroads.xls Note that savings build through year 4. Also, that we stay above $12,000 balance there through year 7 ? then the portfolio withdrawals have to start. In the end, he still has $30,000 of his portfolio and all of the savings ? but inflation?s going to pretty well eliminate the portfolio in year 21. 2. Here?s a scenario where we need to know what he can spend without touching the $180,000 in principal and without touching the $12,000 in savings. In this case, we have to reduce the spending not covered by Social Security ($15,000) enough that interest from growing savings in the early years can keep an Annual Investment Net that doesn?t drop savings below $12,000. You can keep changing the number in cell B26 until you get there ? the number is $12,019 ? PLUS his inflation-indexed Social Security of $9,000 = $21,019. That in contrast to $24,000 per year above but says that reducing monthly spending from $2,000 per month to about $1,752 will leave the principal in his portfolio, his savings and his house investment in place should Roadsie live beyond 90. 3. Scenario #3 sets up an annuity for his investment portfolio and adds the Social Security and savings: In Excel this is calculated with PMT function, the same function that would be used to calculate a loan. In this case, it?s an annuity, with money coming back each month to Mr. Roads: PMT(rate,nper,pv,fv,type) Rate: is the interest rate for the loan ? and this has to match the term (if monthly, then 0.75% or if yearly, then 9%) Nper is the total number of payments for the loan, here 20 years Pv is the present value or principal -- $180,000. Fv is the future value, or a cash balance you want to attain after the last payment is made. If fv is omitted, it is assumed to be 0 (zero), that is, the future value of a loan is 0. Type is the number 0 (zero) or 1 and indicates when payments are due. We?ll make sure that he has the money at the beginning of each year, a 1. The $180,000 paid as an annuity would be $18,090. With Social Security and cash from savings he?d have about $27,690 annually. Note that he could actually spend a bit more because his $18,090 tucked in a savings account would earn another $452.25 in savings ? you can add that or ignore it (I'd add it). Adding it brings annual spending to $28,142.

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