Currently I am working on my financial life planning. Since several weeks I try to understand the FIRE-principal in a deeper way than before. As I am not made for living my life mostly frugal with a savings rate abover 50%, I am working on the different aspects of this principal to be implemented in my financial life.
And here I came to a point where I had to determine, that for me it is not the savingsrate in total which counts. It is more what I do with this saved money, to receive so called passive income from it. Of course you guys know me from P2P lending, where this passive income stream is typical. But would you invest your whole money into P2P lending? I would not.
My problem without a financial life planning
Living in Germany and working here gives you the intention you will be taken care of, when you drop out of your working life at the age of 67. Our pension system is based on a we-take-care-for-the-elderly-idea. Today one hundred working persons take care of 51 to 57 retired persons. And this share will rise to about 75 to 78 in 2050.
Officially I will retire in 2048. And than I will be one retiree of 78, who will be paid through the pension from one hundred working persons. If you check the inflation rate of the last 50 years, it is somewhere between 0,5% and 2%. So let’s assume the worst case and inflation is 2% for the next 28 years.
Furthermore people will receive salary rises over the next years. If you compare 1990 to 2018, which is 28 years, the average income raised by about 62%. Let’s say this comes linear, it is a 2,2% payrise per year.
So, 2,2% average payrise in relation to 2% inflation rate are about 0,2% net payrise per year. Less people earning 0,2% more try to take care of 31,5% more people related to the above mentioned indicator per one hundred – sorry, but this cannot work as you can see clearly.
Financial life planning as a holistic planning
Our government is responsible for everyone, but how will they be able to help here? Less income, but more spendings – the only way is to cut expenses and therewith cutting the pension. So getting the point here is essential, the earlier you work on that topic.
And therewith the topic of financial life planning becomes even more important than it was before. While working on our wealth before, we have to focus on investing into assets, which will pay our “personal pension” from that time on, we drop out of business.
Everyone not taking care about it, will struggle with age poverty. At that age you will not be able to perform like a 30 or 40 year old. Your possibilities will be restricted (from todays point of view) and you have to rely one someone, who is earning less and has to spend more.
So there is no question about financial life planning. You are just able to ignore the problem, but when thinking about it properly you have to decide to either life in age poverty or massively do something today. As I turn forty this year I guess it is not too late to start, but ten or twenty years earlier would have been a big advantage for my personal pension.
How to start with your holistic financial planning?
At first I think it is important to understand the problem here in Germany. You have to the same topic in any society where the average age is higher. In Great Britain and the US there are already other systems implemented like the 401k. Here you have to safe money instead of paying into an state-owned pension fund.
I started with calculating the gap between what I my assets are paying me now and what they have to pay me later. Today our needs are quite high due to the lifestyle and our kids. The kids will leave the house somewhen and I guess it is not necessary to keep such a big house close to a town, which is quite expensive. But let’s assume our todays financial needs are what we need when entering the pension.
As I already showed inflation and payrises usually don’t differ that much. When our todays needs are at for example 4.000 Euro, we just have to calculate it with 1,8% rise for the next 28 years. This is, just like the same time from 1990 – 2019 another 64% rise. Todays 4k are worth the 6,6k in 2048.
Here we are, that is my goal: 6.600 Euro income per month in 2048!
Rule of thumb: One hundred minus age is your share of stock-shares
Saving your money in the bank will bring you no yield. There are some banks offering 0,8% on your investment, but that is not what I have to aim for. Looking at the S&P 500 Chart of the last fifty years shows you an average performance of around 8%. It is the same at the German Dax30 or American Dow100.
Investing into stocks is what is recommended in the US, in GB and elsewhere to take responsibilities of your future income. And this makes sense, when you compare todays 0,8% to 1,5% on bank accounts with those 8% on the stock market.
The rule of thumb says, that your share of stocks should decrease a tiny bit with every year of age. It avoids to drop out of the business within a stocks crash and having maybe -50% in your stocks portfolio. So the risk is reduced by this formular. The more you take off the stock market and invest it into stable bonds, the less crash-risk you have theoretically.
In my case as I am bit late I have to take some bigger risks and decided to take invest 85% into shares (and other assets like P2P lending). Just 15% are invested in a ETF based on bonds.
Calculate your monthly savingsrate to hit your target
Now we are coming to a point which might be quite uncomfortable. When I realized, it was definitely uncomfortable. Let’s talk about the savingsrate. Therefore I will use my own as an example. This rate depends strongly on your needs, which depend on your life. Single persons do have another need that families. So please calculate your own rate and maybe copy my way, but not with my numbers.
I will focus on capital income and not on growth. So, receiving 6.600 Euro per months, sums up to a total of 79,200 Euro per year. Parts of this have to be taxed. As taxes are quite different over the world, I would like to calculate with a rate of 50% for any taxes, funds and whatever. There fore I calculate with a income of 4% from my assets, which is 50% of the average 8%.
79200 / 4 * 100 = 1.980.000 Euro
This is the sum I need to have in my account to pay me 6.600 Euro per month in 2048. Sounds quite huge, BUT lets calculate the other way. What do you have to invest every month to reach this sum?
1.980.000 Euro in 28 years at a yield of 8% = 1.658 Euro with annual yield-payment or 1.575 Euro with monthly yield-payment.
By the way, if I had started at the age of 30 ten years earlier, the rate would be just 717 Euro (annual) or 665 Euro (monthly).
Your life, your rules, your financial life planning
I already mentioned that those are my examples. Your needs, your expenses and your whatever might be completely different. It should be, as you are not like me. But overall you get an idea how to start with your financial life planning. It is essential. And it is dumb to not care about it and rely on others.
As I don’t want to take the risk what our government decides the next 28 about our pension system, I have to take care of my of own finances and my pension. Of course this includes a very uncomfortable number of 1.700 Euro savings per month, but isn’t this worth it? Just imagine your relied on the pension system and they cut the pension the next 28 years down to maybe just 50% of your todays salary?
And of course your have to pay taxes on that one. So it is maybe just 30%-35% of your current salary what you will receive as a pension. Are you able and willing to reduce your life by 70%. No question, 10% or 15% are easy, when the kids move out and earn their money. But 70%? I don’t want to take that risk.
Use legal methods to improve your yield
There are possibilities to improve the performance of your assets. But those always depend on your tax- and legal-system in your country. Here in Germany for example P2P lending is categorized as something like “alternative assets”. Therefore you can write a letter to your tax institution claiming those investments in P2P lending to not be taxed until the payout. You have to pay taxes on this capital income, but there is a difference whether you do it now and every year or in 2048.
Let’s say out of this monthly savingsrate of 1.700 Euro I invest 20% (340 Euro) into P2P lending. The yield is 10% straight. The taxes here in Germany are around 30% on capital income – roughly calculated to make it easier.
After 28 years investing those 340 Euro every month, the total tax payment (sum of all the years) will be around 104.000 Euro. I would have paid 114.240 Euro into P2P lending and gained a total 344.248 Euro of interest. Deducted by the taxes the overall asset is 355.214 Euro in 2048.
In comparison with paying the taxes at the end of the investment period the total sum is 627.588 Euro. Here you have to 30% taxes from, which is 188.276 Euro. I will have paid the same 114.240 Euro into the asset, but the sum after paying taxes in 2048 will be 439.312 Euro, which is 84.000 Euro than you have when you paid the taxes every year.
Take responsibility for your own financial life planning
So please get informed about the possibilities in your country and what you have to do to use them. Using every possibility will have a massive impact on your assets and therewith on your own pension payment later in your life. Taking responsibility today and getting through uncomfortable situations will pay off later.
And even if you are not able to save and invest the full sum today, you should start where you are right now. A side hustle or a small job at the weekend will raise your savingsrate tremendously.
Just imagine you are able to gain another 100 to 500 Euro from a side hustle. You would be able to save less from your monthly salary OR you invest more and reach your goal years earlier.
So, whatever you do: Make a financial life planning and stick to your numbers and figures to not have to rely on someone elses mood in 20, 30 or 40 years. You don’t know what will happen in the future, but you can do something today, which cushioning any decision made from the government in the future. And even if they rise the taxes on capital income to 50%, you will still have a lot more tha