Financial Security in a Persons Retirement - Term Paper Example

MBA 570 CORPORATE FINANCE SPRING II 2015 Abstract Financial Security in a person’s retirement does not just happen, however, it takes planning as well as commitment and, yes, money. Less than half of Americans have actually calculated the amount of money need to save for their retirement. In 2012, 30 percent of workers in private industry who have access to a defined contribution plan, for instance, a 401(k) plan failed to take part. In addition, the average American spends at least 20 years in their retirement. Saving matters, therefore, putting money away for our retirement is a habit we are all able to live with. In order to have financial security in our retirement, we need to start saving, keep saving and also stick to our goals. We need to make saving for the retirement a priority. In order to stay focused, we need to know our retirement needs and save towards it. A good starting point is finding out our retirement benefits. Introduction Investing for retirement is vital in ensuring safe and enjoyable retirement. Due to uncertainty, the true quality of a person’s retirement actually depends on their planning and planning must begin somewhere (Berk & DeMarzo, 2014). To have a secure retirement one must understand all the necessary factors that are crucial in the realization of the set goal. In saving for retirement individuals must understand the time value of money concept because it influences any financial decision to be made. They need to start saving early enough to increase the worth of the money in future. It is the idea that money available today is worth more than the same amount in future because of its potential earning capacity (Taillard, 2013). Because money earn interest, any amount of money is often worth more the sooner it is invested. The paper entails computation of the amount to be invested annually to earn $1,000,000 in 30 years and the amount earned at retirement. In addition, it discusses values such as time and interest rate that can be changed to lower annual deposits while increasing benefits. Besides, it discusses asset allocation among three asset classes, stocks, bonds and cash. It concludes by looking at investment objective which in this case is capital appreciation. Further, it discusses investment constraints that affect my asset allocation. Methodology In solving the problem, I will use the money purchase method which takes into account annual deposits and actuarial factor that is based on annuity period (time horizon or age) (Berk & DeMarzo, 2014). This method takes into account time value of money by using present value or ordinary annuity (Berk & DeMarzo, 2009). It is the product of annual deposits and present value interest factor of an annuity. Analysis: How much to be invested each year to accumulate $1,000,000. In determining the amount of money to invest, we get the payment of an ordinary annuity with a future value of $1000, 000. This is calculated as follows: Present Value of an Annuity= PMT (PVIFA (10%, 30 years) $1,000,000= PMT{1-(1+0.1)-30/0.1} PMT= $1,000,000/9.4269 PMT= $106,079.25 By depositing $106,079.25 annually for 30 years at 10 percent, I will accumulate $1 million for my retirement. How much to be earned in your retirement In this case we get how the total amount $1000, 000 will be distributed in the retirement period of 25 years. In that case we also compute the payment (PMT) Retirement payment is the annual payment made annually for the 25 years. Retirement payment (PMT) = FV/ PMT (PVIFA (10%, 25 years) (Ehrhardt & Brigham, 2010) PMT= $1000, 000/{1-(1+0.1)-25/0.1} PMT= $1000000/8.5136 PMT= $117,459.62 My retirement payment or benefit will be $117,459.62 annually or $9,788.30 (117459.62/12) monthly Variable(s) that could be changed The first variable I can change is time. I can delay my retirement past my full retirement age. This increases my social security benefits a certain percentage if I delay receiving benefits until after my full retirement age (Berk & DeMarzo, 2014). In doing so, my benefits will increase until I start taking benefits or until I reach age 70. Spreading the annual payments over a large period of time increases the benefits and decreases the annual deposits. The annual retirement benefits will increase because they will now be spread over a period of just 20 years instead 25 years. The second factor is interest rate. I would look for a bank that offers a greater rate of interest on investment. A higher interest rate results in higher present value interest factor thus decreasing annual deposits and at the same time increases annual retirement benefits. Asset allocation of the investment Asset allocation is the division of investment portfolio among diverse asset categories. This depends on time horizon as well as risk tolerance. Since I have a longer time horizon, 30 year, I am comfortable with taking riskier or more volatile investments because I can wait out slow economic cycles as well as the inevitable fluctuations in the markets (Taillard, 2013). Also, since I am high risk tolerant or aggressive investors I am more likely to risk losing money so as to getter better results and increase my benefits. Considering my risk tolerance and the longer time horizon, I would allocate my investment among the asset classes as follows. Having the highest returns though with the greatest risk, I would allocate 45.5 percent of the total investment to equities (stocks) because they offer the greatest potential for growth and I have the time required (Ehrhardt & Brigham, 2010). Being less volatile but offer more modest returns, I would allocate 32.5 percent to fixed income (bonds). This will help in neutralizing the high risk present in stocks. The remaining three, being the safest, I would allocate my investment as follows: real estate (6.5%), gold, 10.5% and money market (cash) 5%. this will help in ensuring my liquidity because such investments are easily accessible. The objective my plan to pursue in my investment From my asset allocation, it is clear that I am going to pursue capital appreciation. This objective is defined as an increase in asset value due to a rise in market price. This objective looks at investments that will increase in value based on the increase in earnings and being an aggressive investor it favors me so much (Quiry & Vernimmen, 2011). It is more appropriate for risk-tolerant investors. Capital appreciation is appropriate for me because it makes portfolio to grow in real terms over time in a bid to meet some future need. This goal helps in building a secure retirement because it helps in wealth accumulation (Ehrhardt & Brigham, 2010). Investment constraints that affect your asset allocation Asset allocation that works best for anyone at any given point in life depends largely on the time horizon and the ability to tolerate risk. Having a longer time horizon, I prefer risky assets because as indicted, I can wait out fluctuations in the market and slow economic cycles. In addition to time horizon, another constraint is risk tolerance (Ehrhardt & Brigham, 2010).  I went for risky assets because of their higher returns and because I am high-risk tolerant. Besides, liquidity affected my asset allocation (Berk & DeMarzo, 2014. In as much, I want high returns, I must maintain some level of liquidity by investing in the safest assets like gold and real estate. Conclusion From the analysis, I am very happy with my investment because they will aid in the realization of my goals and objectives. Risky assets offer high returns and this increases the retirement benefits. On the other hand, as a way of diversification, I have relatively high investment in safe assets (cash and bonds). This will help in providing cushion should losses arise in the risky assets. Stocks are often the best for long-term growth and a healthy dose will help in ensuring that the savings grow faster than inflation, thereby increasing the purchasing power of my total investment. References Berk, J. B., & DeMarzo, P. M. (2009). Corporate finance: The core. Boston, Mass: Pearson Prentice Hall. Berk, J. B., & DeMarzo, P. M. (2014). Corporate finance: The core. Ehrhardt, M. C., & Brigham, E. F. (2010). Corporate finance: A focused approach. New York: South-Western [u.a.. Quiry, P., & Vernimmen, P. (2011). Corporate finance: Theory and practice. Chicester, West Sussex, U.K: Wiley. Taillard, M. (2013). Corporate finance for dummies. Hoboken, NJ: John Wiley & Sons, Incorporated. Read More