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Financial Planning

Not all Financial Planners are equal. Some lack a basic mathematical background and some lack common sense. Two financial planners for a major Canadian bank listed in a newspaper article, gave a list of tips for retirement.

They said, create a lifestyle budget, pay yourself first and have emergency planning in place. I agree completely as these are all excellent suggestions not too mention common sense. The suggestion, of not living debt free provided there is sufficient income “to service the loans” is pure nonsense. Servicing a loan whether it is a personal loan or a mortgage means you are paying interest to someone else. The only time paying interest can be justified when retired is when it is being paid to you.

The last retirement suggestion, really an idea, is either a misunderstanding of present value future value calculations or a typo. They said a 2 percent inflation rate would make your “present –day values” worth half as much in 25 years. The phrase "an annual rate of just 2 percent a year" is inaccurate on two counts. First it should be called the "annual compounded rate" and secondly inflation would have to be approximately 2.81 percent per year over the twenty five years in order for something to be worth half as much in the future.

Using the Rule of 72 (an approximate rule of thumb that says 72 divided by the annual compounded rate of return gives the time in years for something to double) easily shows that 72/2%=36 years for an investment to double in value growing at 2% per year annually compounded. The accurate answer using the Present Value Future Value formula (grade 12 mathematics) is 35.003 years.

Conversely at 2% inflation, annually compounded, it takes 36 years for an amount to be worth half as much in the future. If these two financial planners don’t know this simple rule of thumb I would be leary of their financial advise regarding my retirement.


 


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