1. Retirement planning in nominal dollars 1
You previously learned how to plan for retirement using real dollar amounts. Here, we are going to extend to nominal dollar calculations.
2. Nominal dollars
We originally focused on creating a model that assumed the same return on our stocks across years. In reality, we know the stock market is volatile, so we will plan with nominal dollars. Nominal dollars are the amount of money you have now, which you know will not buy the same amount of goods later due to inflation.
The model includes a security horizon, which is a 10 to 15 year period of safe investments to withdraw money from when the stock market is poor due to volatility. You will sell stocks across years to ensure you have enough money. This model is complex, and we will break it down into pieces in these videos.
3. Fixed information
Create a sheet for the fixed model information: return on income, return on stocks, ordinary tax rate, capital gains tax rates, inflation rates, initial balance, initial withdrawal, and security horizon.
The returns are expected interest rates on your money. The ordinary tax rate is the amount of income tax you would pay in a normal year, while the capital gains tax rate is the tax on any investment profits you make. Inflation is the increasing cost of items each year.
These numbers are our best guess for the variables that impact retirement planning. The values can be adjusted to plan for different retirement scenarios.
4. Yearly information
Let's start by calculating our yearly balance in retirement funds by setting the first year equal to the initial balance cell or B8. After that, we use the fixed income balance plus the stock holding balance plus the money withdrawn. We calculate the income balances separate from the stock balances, as they have different interest and tax rates.
5. Fixed income pv() function
The fixed income balance is the portion of your total balance that you keep as income while designating a portion for stock holdings. We will use the pv() function. The first argument is the rate, which is 1 plus the return on fixed income times 1 minus the ordinary tax rate divided by 1 plus the inflation rate minus 1. This formula accounts for the different taxes and inflation rates. The number of periods argument is the security years minus 1, and the payment amount is the annual withdrawal as a negative number.
6. Fixed income in action
Here is the pv() function on our model sheet; remember to use parentheses and absolute references when creating this formula.
7. Stock sales after taxes
You will need to sell stocks each year to maintain your annual withdrawal in retirement, and this value is equal to the end of year fixed income minus the beginning of year minus the annual withdrawal amount.
8. Stock holdings
The stock holding amount is how much stock you are keeping to sell when necessary. This value is equal to the total beginning balance minus the fixed income beginning balance minus the annual withdrawal amount.
9. Stock holdings year 2 and on
After year one, you have to calculate the amount of stocks to continue to hold based on a ratio of sales to taxes. This formula allows you to maintain money for taxes and your fixed income. The formula is year-end stock holding plus stock sales divided by one minus capital gains tax plus capital gains tax times last year's tax basis divided by last year's end stock holding. A tax basis is provided for you, and this value is the price of bought stocks minus any previously sold stock.
10. Try it yourself!
Let's create the first half of our nominal dollar retirement model.