The Financial Planning Process: How to Mastermind Your Retirement (2024)

The financial planning process is all about “planning” for your retirement far before your arrival there. You need to think of retirement as a destination. I like to call it “The Promised Land!”

While it may seem like a magical place (with margaritas) where we dream of going (someday), it's actually going to be real. And you can't click your heels to make it appear right when you're ready to retire. You have to start planning for it now.

Thinking about retirement in this mystical, far-off way is common. But it's also a mistake. I want to help you demystify retirement and think about it more practically.

Here’s the thing…notice how I called retirement “a destination”? Now, have you ever gone on a long road trip, with a particular destination in mind, without using a map? No. You haven't!

Unfortunately, so many people are on a very long, winding road trip to their retirement destination and have never even opened up a map. No wonder they feel so lost!

So, we are going to (metaphorically) open up a map, and then we will “highlight” your individualized path to retirement. (I’m 45, so when we went on family car trips we literally looked at maps printed on paper and “highlighted our route.” Just wanted to clarify that reference for some of you young whipper-snappers.)

Let’s open our maps (sure, phones…whatever).

Decide Where You Are Going, Then Figure Out How to Get There

So let's think about your road trip…what is your first step? No, you don't get in your car and start driving! You decide where you are going first! Then you start to map out the best way to get there.

6 steps to map out your retirement plan

Now in order to create that “map,” you need to follow these 6 steps.

1. Decide what you want your retirement to look like and by when (location, activities, etc).

2. Figure out how much money it will take to make that retirement (from step 1) become a reality.

3. Consider what kind of investment performance you can rely on to supercharge your savings effort, which will in turn fund your retirement days.

4. Determine how much money you need to save along the way and put it into your “supercharger-machine” to accumulate that nest egg.

5. Start tracking your finances to establish a total required ongoing income to survive the trip to retirement. Then keep “tracking” them so you stay “on track.”

6. Examine your income sources (also known as your job), and determine if your income is sufficient to get you to your destination.

See…this is easy! I mean, it's not like you have to try to “map” out your whole life in advance in order to have a plan with a high probability of success, right?.

Wait…shoot…actually, you do. That might be tough…maybe we should just stop doing this and hope for the best. Ha! Kidding.

I know it's “a lot”

I fully realize part of the reason people don't do this is because 1) it takes some work, and 2) doing it will very often fully expose the harsh reality that this road trip isn't going to always be “a hoot.”

It may also “lift the kimono” on the fact that your financial decision-making to date literally has you driving in the opposite direction of your destination. That’s a tough one to accept.

But here’s the thing: you need to do this! You only know if you are on a decent path after you look at the map. You may actually find out that you are doing just fine! But you have to know.

I think this is where I say, “Knowledge is power!” Yep…that was well-timed.

You can get some help

If it makes you feel any better, you can get help doing this. Many “wealth management” firms will help you with this.

The slight problem with wealth management firms is that they will only plan your path for you if you have enough money to invest with them…and you need to do this as early in your life as possible.

Drilling Down Into the “Trip-Tic”

(Yes. That references the old flippable AAA maps you would get in the 80’s and 90’s.)

Ok, let’s get into some detail on our 6 steps. Despite all my moaning above, you don't have to get super crazy on this planning. You can make a lot of educated guesses. Life is long, so you will have plenty of time to adjust.

1. Decide what you want your retirement to look like and by when

This step is basically you daydreaming of a blissful time in the far-off future. What will you be doing in this blissful future? Golfing? Volunteering? Traveling? Hitting the bar at 10am? All of the above?

This may be a strange thing to try and imagine but do your best. It doesn't have to be perfect and it can change over time. Actually, the more specific questions you want to be asking are…

-Will you be working? Or would you be willing to work part-time if need be?

-Where will you live? Will you be willing to move to a lower-cost-of-living area? Perhaps even outside the United States?

-Will you be residing in a house or something smaller? Will you have more than one residence? Will you own your residence or rent it?

-Is traveling a part of the picture? (This is a stand-alone because it’s expensive.)

-Are there other specific leisure activities you like to do, such as golf, boating, fishing, cycling, running Ironman triathlons? And how much do these activities cost?

-And finally, at what age would you like to be doing this?

2. Figure out how much money it will take to make that vision (from step 1) become a reality.

This step is one of the most important.

This is where you say to yourself, “How much money would I need to have every month (or year) at my disposal, to have this blissful future retirement scenario play out? This pool of money would include investments, income from a part-time job perhaps, or any other sources of income.

Create a “retirement living” budget

Let’s look at an example. I’m going to start with a couple that likes to be active and spends money on leisure but lives in an area with a lower cost of living.

Plus, they like to travel a decent amount. They have Medicare with a supplemental plan, one car, and a smaller housing payment because they own their home outright. Based on this profile, here is an example budget.

Also, FYI if you like videos. This is a good one!

Adjust for taxes, pensions, social security, part-time work and then inflation

Once you have your budget, you need to factor in taxes you will be paying on your retirement distributions, as well as some hopeful social security that you may be receiving.

If you are lucky enough to have a pension, you'll want to factor that in. And also add in any amount of income you might make doing part-time work (if you were open to working at all).

Now, here's the trick on this. You need to take the final monthly/annual total and adjust this number for inflation.

So if you are 25 today and want to retire at 65, you need to adjust for 40 years of inflation. Why? Because you will be living off this budget 40 years from now…and “stuff” will most likely cost more.

Calculate all of this and you will get…

…your required income to be provided by your Retirement Fund! This is the amount of money that will come from your retirement nest egg to support your retirement life. And for a little more clarity on that…

Now there are two possible ways you get money from your retirement nest fund, which we’ll call the “principal.” You will either draw off of the principle itself and spend that, or your principle will generate more money via the investment vehicle(s) your retirement principal is in.

You want to be doing the latter as much as possible. Enter the…

“Multiply by 25,” working in tandem with the “4%” Rule(s)

Ok, so there are a handful of generally accepted tenants of retirement planning. And these tenants are based on some pretty significant assumptions. Let’s take a look at what a couple of them are.

First, the Multiply By 25 Rule states that to determine a decent “accumulation target” for your retirement nest egg, you multiply your desired annual income by 25.

From there, enter the 4% Rule which says you should withdraw, from your total principal and interest accumulation, 4% annually. And that 4% withdrawal would then increase annually by 3% to keep up with inflation.

3. Consider what kind of investment performance you can rely on to both supercharge your savings effort, and then fund your retirement days.

So now you might be saying, “But wait, you said I should not be tapping the principal…so how do you take 4% per year, and also increase that 4% by 3% annually to keep up with inflation?”

(Man…you are really paying attention here. Nice work.)

More on the “Multiply by 25,” working in tandem with the “4%,” Rule(s)

Well the “Multiply by 25,” working in tandem with the “4%” Rule makes a pretty big assumption, which is: you will need to regularly be making 7% compound annual growth on your “retirement nest egg principle.”

When you make 7% return and only withdraw 4%, you leave 3% of your gains in the account, increasing your principal.

(Technically, you need 7.29% because you spend years worth of money in the first year of growth. But who’s counting?)

This annual increase in principle keeps your nest egg growing with inflation. It also means your 4% withdrawal will be increasing by 3% each year as well. Nifty!

The perpetual money machine that is your savings

This system theoretically creates a perpetual money machine that produces your income until you die. Then you get to leave the principal to your heirs. Yah!

Now, you don't have to leave the principal to your heirs. You can give it to me! Or you can spend more in retirement, and draw it down to nada. Just don't die before it's all gone! That's the trick with that.

You also may not end up amassing your nest egg goal, and you may not always get that 7% return. So in that case, you would have to adjust your spending, or draw on your principal.

It’s hard to get this nailed down perfectly, so we are creating a plan to achieve the best results and then hoping we get as close to it as we can. I mean, what else can you do, right?!

Now, let's take a look at how the above points play out…

Ok, so we hope to make around 7.29% return on your retirement nest egg, while in retirement. When we are NOT IN RETIREMENT (aka you’re working full time), we want to make as much moola as humanly possible so that we get your retirement nest egg to it’s accumulation goal asap.

Are either of those things doable, you ask?!?

A quick rundown of potential investment returns in the markets

The answer is, “Hopefully!” There's a lot to say on this topic, but I'm going to boil it down to a couple of main points.

The historic performance of the S&P 500 is the basic benchmark that the entire financial industry uses to measure its performance against.

That is “roughly” around 10% annual compound growth for the last 100 years, assuming you reinvested all dividends. But keep in mind this is an average.

If you look at different entry and exit points (when you put money in or take it out), that number would change.

So that's the high end of performance for your retirement nest egg. That's not to say you can't get lucky and do better, but statistically, that's hard to do in the public markets.

Also note that investing strictly in the S&P 500 would be considered higher risk, which you don't want to do in retirement.

In retirement, you want principal preservation. Before retirement, you could employ a higher risk strategy, though.

The low end of the investment returns spectrum would be vehicles with little to no risk, thereby having little to no return.

This would be something like a bank savings account, in which you would have “cash,” or perhaps US Treasures. Something where your principal is as close to 100% safe as possible.

Being that these would be considered the least risky investments, consequently the return onthese would be around .5-1.5% today (given where “rates” are today). That's not the 7% you are looking for, now is it?

Furthermore, it’s lower than average inflation. So, let’s do the math: if the cost of goods went up by 3% last year, and your investments only made 1.5% return, that means you lost 1.5% of your money. No bueno.

What else you should know about investing

So again, ultimately when you hear all this mumbo jumbo about the importance of investing, the purpose of it all is to build up your retirement nest egg, and then live off your retirement nest egg…without it disappearing before you die. Simple really.

Beyond that point, and the info on returns I mentioned above, there are a couple more things to consider.

Why are people are always talking about “risk tolerance”?

Yeah…this whole risk tolerance” thing is weird. I find it to be a funny term, because who do you know that really has a “tolerance” for losing money? I know I don’t.

So I like to define risk tolerance instead as: your willingness to keep working because of a sharp and/or prolonged market downturn.

If your risk tolerance is “high,” that means you plan on being in the full-time work force for at least 10 more years. If you are 20, then your risk tolerance is “very high,” as you are potentially looking at 30-40 more years of work.

Conversely, if you want to quit working, or even start working part-time (in a “semi-retirement” type situation), your risk tolerance is “very low.”

Types of Investments

Public Markets

The stock and bond markets are the most common places to invest your money for growth. If you think that is your best bet, please read these articles I’ve written discussing the levels of returns you might reasonably expect while investing. They also cover the various methods of investing and associated risk.

Big Picture Investing: Why You Need to Get in the Game Now!

How to Make Your Money Work for You: 7 Modern Methods for Investing in “The Market”

Real Estate

Aside from public markets, the most common way to invest your money along the way, and in retirement, is personally owned real estate. Personally owned real estate refers to owning an actual property yourself. This includes residential rentals, commercial rentals, and even positions in syndication deals.

If you want to read more about investing in real estate, check out these three articles I wrote on the subject…

Real Estate Strategy 101: Learn the Basics, the Lingo, and the Opportunities

Renting vs Owning: Why You Need to Own the Real Estate You Live In (of Which You Will Be the World’s Best Renter!)The 5 Critical Components of Real Estate Investing Returns

Alternative Investments

Outside of those two categories, you can also look at alternative investments.

An alternative investment is a financial asset that does not fall into one of the conventional investment categories. Conventional categories include stocks, bonds, and cash.

Now technically, real estate investments would be considered alternative investments, but I put it in its own category. Precious metals like gold would also be considered alternatives, but since they are widely accessible by ETFs, I don't think they are.

Alternative investments would include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, derivatives contracts, and private companies. You can even do things like business equipment leases, or physical assets like oil wells.

However, most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals (somebody with around $1 million in liquid financial assets) because of their complex nature, lack of regulation, and degree of risk.

4. Determine how much money you need to save along the way to put into your “supercharger-machine” to accumulate that nest egg.

Ok, so in this step you would want to play around with my savings rate calculator (which you access in the course, of course!).

Many variables happen in one's life (and in my calculator), especially over the 30-45 years you will be working. But I tried to lay out the basic metrics that contribute to accumulation.

Gross and Net Pay: Forgive me if this sounds basic, but I’ve learned that people often do not fully understand their paycheck. Your gross pay is the salary your employer pays you. Your net pay is what you receive after they deduct your personal federal and state taxes and send them to the government on your behalf.

If you have a retirement account, that means your savings comes right off your gross pay, and you pay taxes on the rest. If you have a regular savings (or brokerage) account, your savings comes out of your net pay. Big difference.

Savings Rate / Invested funds: Your savings rate is the amount of money you put aside to invest every month. You may decide to make this a percentage of your income or a flat amount. Once you figure out how much you need to invest, and make your monthly budget, you will know what is practical for your current circ*mstances.

Remainder (for Living Expenses): This is what you have left over after you pay your taxes and pit away your savings. It's the amount of money you will have to live off of. What's important here, is to determine if you can in fact live off it! (We'll do this later.)

Investment Growth: This is the amount of new money your hard earned money made for you while you slept…or while you were working, or in the shower. It’s, ya know…the stuff that dreams are made of.

Windfall Events: Windfall events are what I call large chunks of money coming in or going out of your life. Like an inheritance, for example, would be an income windfall. Paying for your kid's college would be a windfall expense. We want to anticipate these as best we can. Some are obviously easier to anticipate than others.

Nest egg growth over time: This is pile of moola that you are adding to with your invested funds, and simultaneously growing with your savings “super-charger” machine. Hopefully you see it getting larger every year. If you don't, we need to have a sit down.

Above is a calculator I made that shows how much your “savings over time,” which is also “compounded over time,” adds up.

I have made it so you can adjust the metrics in red and see how different scenarios play out and how that affects your nest egg accumulation. (This calculator is available in one of my courses, the Financial Independence Roadmap .)

The simulator will help you figure out how much you need to be saving, and by when, to reach your goal. You then incorporate those required savings into your budget.

If you create something like this for yourself, you can start to plug in real numbers at the end of every year, and essentially merge reality with your plan.

You want to do this so that you can see if your progress has you inching towards your goal, or potentially getting there sooner!

5. Start tracking your finances so you can establish a total required ongoing income to survive the trip to retirement. Then keep “tracking” them so you stay “on track.”

The reason it’s so important to track your finances is multifold. I actually wrote a somewhat humorous essay of sorts on the topic of money tracking (aka personal bookkeeping).

Beyond the tracking itself, there are a few more steps involved with this stage of the planning, so that you eventually glean the information you need.

1. You have to track your income and expenses (with a computer) so you can really see how much your current life costs you.
2. Take those expenses and put them into a spreadsheet. Then try to find areas where you think you can spend less (and save more). This would be your new budget.
3. Once you have your new budget in hand, you have to look at your net pay minus your required savings. You can see if you will have enough money left over every month to cover your general budgeted life expenses.
4. Understand that if you are “saving money” on one hand, but going into credit card debt in the other, you are not actually saving money. You need to make more than you spend to save money. Sounds obvious, but a lot of people don’t get this.

(Here is a sample budget. I decided to make one for a young, single person. It lines up with the beginning of the savings plan above.)

You might also be saying to yourself, “Dang, I'm not sure I make enough money to ensure that after I pay taxes and take out my savings, the remainder covers my budgeted expenses!”

This is a common problem, actually.

There are two ways to fix this: 1) spend less or 2) make more.

The former has limited potential, in that you can only “not spend” so much. The latter has a lot more potential! The old adage “the best defense is a good offense” applies here.

If you don't employ one of these two resolutions, you will not meet your savings goals. You may even start racking up credit card debt. Boo.

So this leads me to the final step in this critical life planning process…

6. Examine your income sources (also known as your job), and determine if your income is sufficient to get you to your destination.

Now, this can be the really hard part of this whole thing. More than likely this worthwhile exercise will show you that you have to amass a pretty serious amount of money to retire comfortably. It can be quite alarming, actually.

Beyond just looking at the large numbers, you also have to look at your current work situation and ask, “Am I currently making enough money to achieve this, and/or does my current career have enough growth potential to keep up with the demands of this plan?”

That’s the scariest part, because you can’t very easily reinvent your work situation. Regardless. you need to look at your income and figure you how you are going to keep increasing it (if need be).

Some of the basic ways to earn more money are…

• Work smarter and strategize. Think about your job as “you running the business of you.” Go above and beyond! Find a side project to take on that will help you stand out! Your employer is the one client of the “business of you”…keep them coming back!

• Beyond working smarter, be proactive about asking for a raise. And when you do, go in armed with all your “above and beyond” accomplishments.

• If growth at work is not an option, think about making a lateral move to another company. The reality is that you often advance more slowly when staying at the same job. Going to a new company gives you a fresh start and more possibility for an advancement.

• Think about starting a side business or doing some extra freelance work from home.

• Once you start making some money on the side, think about incorporating yourself so you can take advantage of more tax benefits and better retirement plans available to the “self-employed.”

• Freelancers and consultants often make significantly more per hour than full time workers, while also having some life flexibility and better tax benefits. Investigate if this is an option for your set of skills.

Some Other Items to Consider Regarding the Financial Planning Process

What I have laid out so far in the post above, is a pretty standard approach to your work life and retirement planning. Obviously life is long and filled with ups and downs, so the odds of this plan playing out exactly as you laid it out over 45 years are…low.

Regardless, it's still extremely important to take a birds-eye view of how things can generally play out, so you can make all the necessary adjustments along the way, to allow you to meet your goals. Knowledge is definitely power in this situation.

You can also play around with what ways you might change the “script” up a bit….

Life in 4 Acts

My wife Kristin and I planned well, but also did quite well in the income department (via both work and investments). Consequently, we were able to “semi-retire” in our early 40’s, so we could spend less time working, and more time with our young son.

By “semi-retire” I mean that we have enough saved, and it also produces some income, so I really only have to cover our expenses with my work. We left our intense work life in Los Angeles, and moved to a cheaper place to live. Due to that fact, I am able to work part-time and she has stopped working to be a full-time mom. We say we are in Act 3 of a 4-Act Life.

What the heck is a 4-act life?? Here’s the difference between living your life in 4 acts versus 3 (roughly speaking, give or take a few years in each period of life).

3-Act Life Approach

Birth to Age 20 – Schooling

Age 20 to age 60 – Working & Accumulation (the dream of the three act life is an early retirement at 60. Woohoo!)

Age 60 to age 80+ – Retire and generally stop working

4-Act Life Approach

Birth to Age 20 – Schooling

Age 20 to age 40 – Working & Accumulation

Age 40 to age 60 – Downshift to part-time work (semi-retire)

Age 60 to age 80+ – Retire and stop working

Ways You Can Get there Sooner

Getting to retirement sooner (early retirement) can be achieved by reducing your current living costs now, thereby saving more money sooner. But it can also be achieved faster if you can reduce the living costs you will incur in the retirement phase. The less you need to live, the less you will need saved!

Here are some specific ideas on how to reach retirement sooner (if that's what you are looking to do)

• Make more money! The main driver of our accumulation is what we earn from our work. You need to constantly look at your work situation and figure out how to make more money.

• Save more money! Figure out how much you are spending, make a budget that “tightens it up,” and then stick to the budget. The more you save, the more you put into your super-charger machine earlier on.

• Own your residence, or better yet, do a “house hack” (buy a multi-unit building, live in one unit and rent the rest) as early in your life as possible. Not only will it lower your housing costs, but it will out-perform market investments (in my experience).

• Have kids in your mid to late 30s. Seriously. I know this isn't always “planned” or an option for everyone. But, consider this. Kids are both expensive and insanely time consuming. Having them later allows you more time to focus on building your career and getting to a higher paying position earlier. Consequently, this puts more in the nest egg earlier, capturing more compound growth!

• Have only one kid. Again, kids are one of the most expensive “hobbies” you will ever take on…haha. You can plan on roughly 10K per year for #1, and 5-6K per additional kid (just going to public school). But then there is potential private school and of course college. A college degree will likely cost 100-300K+ per child! (in today's money).

• Determine if you can work from home, reducing your commuting costs. This may allow you to go down to one car even!

• Move to (or retire to) another state with a lower cost of living. Specifically, lower housing costs in terms of rent or insurance and property taxes.

• Consider retiring in another country (seriously). Many people move to countries with not only lower costs of living, but lower costs of health care! International Living Magazine will tell you all about it (it's an awesome magazine).

• Get some freelance work on the side, givingyou extra money. Then,incorporate yourself to take advantage of tax benefits business owners get!

• Figure out how to get your investments to perform at much higher returns than expected averages. Whether that be in the stock market, real estate, or alternatives. The more your money can grow while you're at work, the faster you will advance! (I have found real estate to be a high performer, averaging 18.5% returns for me.)

There are many other ways to spend less, save more and be strategic about reaching the “promised land.” I may write a post devoted to this topic! Keep an eye out for that.

Wrapping Up This Epic Financial Planning Process Post

Man…what else can I say! I feel like I covered it all.

I guess I would like to part by saying that I know this can feel overwhelming and possibly downright impossible. But don't let it discourage you.

As I've said before, life is long and there is a lot of time to both make adjustments and make up for some less productive years in your life.

You can do the steps in this post in one weekend, then forget about it for a few years. Just by planting these well-informed seeds in the back of your brain, you will greatly advance your journey to “The Promised Land.”