Question

You are a financial advisor helping a 35-year-old woman plan for her retirement years. She currently makes $75k/ year at her job. She estimates that her salary will keep up with inflation - nothing less, nothing more. She intends to retire at age 65. How much would you suggest she invest every month towards her retirement? Assume that she is not familiar with TVM terms, provide a letter to her that explains your recommendation and your reasoning -- in plain terms.

** For #4, you will need to research and provide some basic assumptions before you begin the math. I'd suggest that the following would be important: expected rate of inflation, the expected rate at which you can invest the money, what % of her current salary will she need in her retirement years, how long would you expect she will live?

Answer 1

As the 50/30/20 Rule, you should reserve 50 percent of your income for food and rent, 30 percent for discretionary spending (travel, shopping etc) and rest 20 percent for savings.

With the current salary she should save 20%*75K i.e 15K every year. If the inflation rate is 5%, her value of savings should decrease by 5% every year but as her salary would keep up with inflation she would be able to save more and her savings per year will be equal to $15K at present value terms.

On an average, US citizens life expectancy is 78.69 years or 80 years (approx) for the old-woman.

At retirement age, discretionary spending and mortgage payments are not needed usually. She should invest in a financial instrument where real rate of return (Nominal return-inflation) is more than zero. For safer, if her investment yield is equal to 5% i.e. equal to inflation rate, then she would be save 15*(65-35)=$450K at present value.

If she spend 25K for food and any other expenses (at present value terms), then she would required  25k*(80-65) or 375K to survive her remaining life.

Hence, she should invest atleast $15K per year and invest in a financial instrument which gives at least  to inflation rate to plan her retirement.