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.
About the Author: Mike Piper writes at Oblivious Investor, where he provides plain-English explanations of topics like Roth IRA rules and 401k rollovers.
Khaleef @ KNS Financial says
Great article! You’ve hit on the two things that bug me the most about these calculators. Assuming that 100% of your income is taxed at your marginal tax rate, and assuming that you will earn your average return each year!
Like you, I prefer to use spreadsheets – even for my clients – so I can play with the assumptions and see the full picture.
Mike Piper says
@Khaleef: Indeed. There’s no way to do any sort of projection without making assumptions. But it’s good to be able to control them yourself and see how the results change when you compare best-case scenarios to worst-case scenarios.
kt- lifedividend says
i am a do it yourself (value) investor and small business owner hoping that my value investing skills get better and my business flourishes. If God blesses the work of my hands, i will also never need to use any calculator. The financially independent people i have met are there mostly because of the financial independence gained from a lifetime of investing and financial discipline and prudence and this is the road i want to travel, vis-a-vis finance.
Rob Bennett says
I don’t agree with Mike. But I believe that anything that causes people to become more skeptical about what they see in all investment calculators is a plus. So I see this article as being a plus.
My view is that the problem with all existing retirement calculators (except the one that I developed — “The Retirement Risk Evaluator”) is that they do not incorporate an adjustment for the valuation level that applies on the day the retirement begins. The historical data shows that that just happens to be the most important factor! So the existing calculators all get the numbers wildly wrong. Mike is of course right that it would be better to have no retirement calculators at all than to have retirement calculators giving people wrong numbers.
We cannot do without retirement calculators, however. The need for such tools is great. Mike suggests consulting a financial advisor. I view that idea as worse than going with a calculator. Where do you think the professionals get their information? They use the existing calculators! If you work the calculator yourself, you may see the flaws. Relying on a professional to do it makes you one additional step removed from the data on which the retirement recommendations are based.
I don’t think an Excel spreadsheet is the answer either. Excel spreadsheets contain assumptions too. You need to make assumptions to know where to put the numbers. Mike believes in Buy-and-Hold Investing. That means that he will not be making adjustments for valuation levels in any retirement planning he does on an Excel spreadsheet. Those who believe that valuations matter do not see how that can work.
My recommendation is that we all do our part to encourage a national debate on the realities of stock investing. We all need to learn more. That very much includes those who today put themselves forward as “experts”!
Any suggestions on how to find a good (and cheap) financial adviser?
Mike Piper says
Jenna, my suggestion for finding a financial advisor would be to start with the search function on the CFP Board of Standards website: http://www.cfp.net/search/
Alternatively, you might want to start with the Garrett Planning Network: http://www.garrettplanningnetwork.com/
From there, I’d suggest narrowing it down to fee-only advisors (rather than those paid on commission), and interviewing advisors face to face to make sure that:
a) You can understand what they’re saying when they explain something, and
b) You’re on the same page regarding investment philosophy.
Wow I never really thought about those problems. Thanks for posting about this. Despite their problems, which I am now aware of, I like to use online retirement calculators. I often use them as a motivational tool not only for myself, but to help others I am trying to convince to start contributing to their 401k:)
Excellent point about average 5% return compared to 5% return every year! Never thought of that!