People often ask me to point them to a decent online retirement planning calculator. I never do.
You see, I don't trust such calculators.
It's not that their math is wrong. (At least, not usually.) The problem is that their calculations are often based on shoddy assumptions and unknowable variables.
You Know What They Say about Assuming…
For example, what rate of return does the calculator assume for your portfolio? Is it reasonable? Or, perhaps, was the calculator programmed to assume that future returns will equal past returns (thereby ignoring the possibility that the U.S. economy won't have the same explosive growth over the next century that it did over the last)?
And what assumptions does the calculator make about future tax rates? From what I've seen, most calculators assume that either:
- All income will be taxed at a flat rate (usually 25% or 28%), or
- Tax brackets will continue to look the same as the 2013 tax brackets all the way into the future.
While I certainly don't know what tax rates will look like three decades from now, I doubt that either of one of those assumptions will turn out to be correct.
And does the calculator account for sequence of returns risk? A portfolio averaging a 5% annual return is very different from earning a 5% return every year. If the calculator doesn't account for that fact, it's going to significantly underestimate the amount of money you'll need to retire safely.
What's Better than an Online Calculator?
If you've taken the time to educate yourself about investing, then you probably don't need an online calculator. A simple excel spreadsheet will function at least as well. (And you get to choose your own assumptions!)
Alternatively, if you haven't taken the time to learn about investing, there's no way for you to judge whether the assumptions that went into the calculator's projections are reasonable.
In other words, there are two routes you can take:
- If you want to be a do-it-yourself investor, super. But rather than rely on online calculators, you'll need a deeper level of understanding if you want to be successful.
- If you don't want to go it alone, that's fine too. But in that case, an online calculator isn't what you need. What you need is a qualified financial advisor.
In my opinion, such calculators are only useful for young investors who are so far away from retirement that none of the relevant variables are known yet. In other words, a completely blind guess from a calculator is almost as good as one from an advisor.