Retirement Planning

Ignore taxes (personal or otherwise) and Social Security/pension benefits for this problem. However, you do need to take inflation into consideration. Your cash flows should include the effects of inflation, and your returns should also include inflation (not have inflation subtracted). Use up-to-date economic projections as of Summer/Fall 2023 as you make your assumptions about what inflation will be, and what the risk-free rate will be in the future.

From Client

1. Im trying to make some big decisions about budgeting and saving for retirement. Im 33 years old. These days, I need about $65,000 per year to live comfortably, and thats getting higher every year with all this inflation. Im not sure what that would translate to at retirement. But Ill need inflows during retirement that grow at inflation during my retirement years. I plan to retire at age 72. The thing is, Im wondering the following: 1) First, what will I need at the time of retirement? What is the big lump sum Im trying to get to?

2. This is the Base Case. I dont have any money invested right now, but I can make my first deposit into the retirement account at the end of the year. If I saved the same exact dollar amount every year starting this year and ending when I retire, how much would I need to save each year without taking any risk to have enough to live comfortably in retirement (when I will not have any other)?

3. I have some spare cash $45,000 that I could invest right now (in addition to the Base Case investments). How much would the extra investment right now impact the amount I have to invest each year? Im assuming it would decrease the amount I have to invest, but Im not sure how much difference it would make, compared to the Base Case. [HINT: You can use Excels PMT functions PV argument, or you can think of this as reducing the FV that you have to hit with your annual investments.]

4. Lets start back at the Base Case, where I have no money invested right now. I might be able to afford to save more every year, instead of identical investment each year. I expect I could at least keep up with inflation and increase the amount Im investing each year by the inflation rate. How would that affect things, i.e., how much would I need to start investing at the end of this year?

5. Lets start back at the Base Case. Its a bit morbid, but I have no idea about how long I should plan on being retired. I think of myself as a woman in pretty good health. My grandparents lived into their late 90s, and my parents are both still alive, thankfully. Suppose I live way longer than 1 In other words, Im asking you do this in nominal dollars and returns, not real dollars and returns. expected. How much would I need to save each year to still retire according to plan (i.e., live long and prosper)? I dont even know how to find expected lifespan data.

6. Lets start back at the Base Case, where I have no money invested right now, and I make the same investment every year. I know Ive been playing it too safe in recent years, putting everything in a money market account. Im willing to take a chance in the stock market. But the thing is I only want to be taking risks until Im in my mid 50s. By my late-50s, I want to be landing the plane, meaning I dont want to be taking risk at that point. Ill still be working and investing, but I know myself, and I wont want to be taking any risk then. How would it affect the identical investment I need to make every year, compared to the Base Case? Its risky, but I bet its less than what I need to invest under the Base Case, right? [HINT: This is in my opinion the toughest part as it involves three stages (high return, low return, retirement). I think the best way is to solve it using Excels GOALSEEK. I will post an example of using it to help you. I recommend using the Excel template of an amortization table. You can combine that with GOALSEEK to quickly solve this.]

7. I would like to have a yearly plan that shows how much I should expect to have in savings at the end of each year up until retirement. Im trying to keep track of my progress and see if Im saving enough. So, for each of the scenarios above (2-6), can you show me a glide path, a year-by-year chart of what my ending account balance should be each year?

Deliverables

1. Produce your own Excel workbook (could be one or more sheets) calculating and answering the clients questions. As is often the case in real-world work, the questions above may not be super-precise. For example, you dont know sometimes if a cash flow is supposed to come at t=40 or t=41. Make your own assumptions based on what the client said. Also, you will have to make assumptions for some of the inputs (inflation, life expectancy, expected returns on the stock market, risk-free rate in the future). Please justify your choices and what sources you used. Here are some examples for data, but feel free to find your own: Life Expectancy: Social Security Administration Life Expectancy Tables Stock Market and Risk-Free Returns: Historical Data from Damodaran at NYU2 Inflation: Survey of Professional Forecasters

2. Produce a short write-up (should not exceed 3 pages) addressed to the client answering their questions and giving the key results. You choose the format in terms of tables or graphs that make things easier for the client to understand. Make sure you communicate to the client the key assumptions and quantify how sensitive your results are to those assumptions. Show some sensitivities that you think are important, e.g., what if inflation in retirement is higher than we expect? How would that impact what I need to save? Compare to the Base Case. Think of the client as financially literate (they understand investing conceptually) but not a finance expert.