Index Gurus Retirement Approach (IGRA)

Index Gurus Retirement Approach (IGRA):

By: Faruk Jaffer, CIO, May 2008

Summary: A method to customize the amount needed for retirement.

Background:

In finance, the discounted cash flow approach describes a method to value a project, company, or financial asset using the concepts of the time value of money. All future cash flows are estimated and discounted to give them a present value. The discount rate used is generally the appropriate cost of capital, and incorporates judgments of the uncertainty of the future cash flows.

Discounted cash flow analysis is widely used in investment finance, real estate development, and corporate financial management. Faruk Jaffer, CIO at Index Gurus, Inc., realizes this same method is beneficial when applied to an individual.

The two main approaches to Retirement Planning:

The popular approach is that your retirement expenses will be 60 to 80 percent of your after-tax income. Even popular brokerage houses like Fidelity are adopting this method. This can be problematic if your needs will be increasing at a greater rate each year. In other words, the cost of living needs may exceed the amount of income to pay off those expenses. The other approach is focusing on a budget analysis. This is basically an itemized list of your income and expenses over a given period of time. Companies make budget projections on a weekly, monthly and yearly basis. For individuals, a monthly budget should suffice.

About the Index Gurus Retirement Approach (IGRA):

Index Gurus believes that a budget analysis is a better gauge to determine retirement needs. Furthermore, one’s future expense in life cannot be plotted on a linear line. Some expenses may increase at a much greater rate than others. An example would be expecting to pay a lot more in insurance, child support, golf, or less in housing expenses and payroll taxes. To compensate for the changing needs, the IGRA allows the individual to customize future expenses in order to produce a current value which is based on forecasted expenses.

IGRA Mathematical Explanation:

The IGRA method focuses on the present value of an individual’s expenditures that are forecasted throughout retirement.

Mathematics:

The model involves accounting for multiple cash flows in multiple time periods.

The sum in today’s dollars can then be used as a reference point to determine the amount of savings that will be required to cover one’s future expenses.

IGRA STEPS:

Step One: Budget Analysis

Since the IGRA is based on future assumptions of expenses during a given time period, the individual must first perform a budget analysis. This analysis represents a starting point to determine the amount of expenses needed to maintain the current lifestyle.

Two websites that one should visit:

Mint: analyze the expenditures in your various financial accounts.

Dinky Town Calculator: use the online calculator to complete the budget analysis. This requires that you enter information by clicking on “expenses calc” and “paycheck calc.”

Step Two: Forecast Expenses

Once a starting point has been established for expenses, then calculate how and when these expenses will change, including the rate of inflation. The assumptions can be detailed from year to year or represent an age bracket like for each decade. Finally, the assumptions will lead to a value of expenses for a given year.

Example of entering values:

AGE	AGE	$Value
60	60-65	70k
61	66-70	50k
62	71-80	40k
63	80-90	40k
64	90-95	45k

Step Three: Calculate Current Savings

In order to determine how much you will need to cover the future expenses, the individual must inventory the current sources of savings. The value of current savings should include all accounts like IRA’s, 401ks, cash value life insurance, trusts, inheritance, annuities, etc..

Step Four: PV of Future Expenses

Calculate the present value of future expenses where the rate is an agreed amount based on the growth of inflation. If you are having trouble calculating this number, then please an advisor at Index Gurus, Inc..

Step Five: Analyze

Compare the current savings with the current value of forecasted expenses. Since both numbers have been discounted, this allows the individual to get an idea of any shortfall or surplus.

About Faruk Jaffer, Chief Investment Officer at Index Gurus, Inc.

Since 1997 as an intern with Merrill Lynch, Faruk Jaffer, has been involved with Wall Street firms. These include retail firms to serve clients, mutual fund companies to work with portfolios, and asset management companies to assist financial advisers. At Index Gurus, Inc. Faruk realized the limitations of many retirement plans on the marketplace that use a cookie-cutter approach. This method was created while he created customized spreadsheets for his clients. Using techniques like the discounted cash flow and the internal rate of return which is often used to value real estate and small business investment, Faruk realized the IGRA approach could also be useful to families.

If you have any comments/suggestions, please let me know by leaving a comment.