Financial Planning

In a broad context, prudence is a virtuous principle that brings to mind careful consideration and foresight-among other things. In terms of economics or accounting, prudence is a fundamental principle that facilitates estimation in an uncertain context. It advocates that you should not overestimate your possessions or underestimate your liabilities and expenses.

As such, we can understand how prudence plays a significant role in a retirement calculation. A retirement calculation uses the premise that you can use present information for planning purposes. No one can argue that the future is certain. Since a retirement calculation requires you to determine or estimate a number of variables, it is important that you avoid creating a pretty picture by favourably overstating and understating critical variables in the calculation.

==Your salary/ salary increase ==

It is generally easy to use a fair estimate from you salary, especially if your salary or salary increases are consistent and predetermined. However, some persons have variable income and/or variable salary increases. In cases like these, it is important to be prudent. If you are in a commissioned job, you should use an average commission, since using your lowest or highest will skew your retirement calculation. For those who do not have preset salary increases, it is better to use a salary increase rate that is on par with inflation at minimum.

== The rate of inflation ==

The rate of inflation is a critical aspect of the retirement calculation as well. It determines whether you can maintain purchasing power with your retirement income. However, inflation fluctuates regularly, making it necessary to use a projected average for future inflation. According to the principle of prudence, since inflation has a negative effect, it is better to overstate it, so that you can easily adjust to worst-case scenarios.

== Your average accumulation rate ==

Many persons would love to get rates of return of 12% and 14%. Indeed, it is tempting to use such ambitious figures when performing a retirement calculation. However, a sensibly diversified retirement portfolio would do well to return those figures on average over a long period. Therefore, it is actually better to understate your accumulation rate, instead of overplaying it when plugging in your figures.

== Target percentage of pre-retirement income ==

When you retire, you should have an idea of what percentage of your retirement income you wish to receive. For example, if you have ambitious retirement plans, you might wish to retain 100% of your last income before retirement. Since many pre-retirees do not properly consider this aspect of planning, they often call an arbitrary percentage or one that is understated. Since there are many risks of retirement, it is far better to reclaim a higher percentage of your pre-retirement income (closer to 100%). Although some of your retirement expenses may be reduced, you have post-retirement inflation and health risks with which to contend.

Several other instances might require you to apply prudence when performing a retirement calculation. The important thing is to avoid presenting an unrealistically favourable estimate of your financial readiness for retirement and allow you to perceive a realistic worst-case scenario. When doing your retirement calculation, you are free to juggle certain figures, such as your average accumulation rate. You should juggle as many variables as you could to provide a worst-case estimate of your financial readiness for retirement.

Think about all the pre-retirees and retirees who did not make any provisions for the economic downturn of 2007/2008. Those who were prudent would have understood that such things can happen. Even though they were still affected, they would likely have limited their losses by managing their risk carefully. Retirees who were optimistic instead of prudent suffered substantial losses and had no idea how to recover. Establishing prudence in your retirement calculations prevents you from unpleasant surprises arising out of a harsh reality check.