Those retirement calculators you find online… they are so convenient, right? They’re easy to use and, well, they’re right there in front on you on almost every financial website you might visit. All you have to do is put in a few assumptions about the future and the retirement calculator instantly tells you how much money you will need to retire.
As with many things that seem too good to be true, this can often be the case with these retirement calculators as well. Sure, they might seem fail-proof and mathematically precise. However, their “accuracy” is also subject to user error. For example, if you input the wrong values for some of the more difficult-to-make assumptions, your “retirement number” can be seriously wrong. Thus, relying on this generated number can jeopardize your retirement goals.
On the other hand, this is not to say all retirement calculators are bad. It’s just they’re only helpful when they’re used properly—with accurate data input as well. The output of these calculators can only be as precise as the assumed numbers used for input.
This article will cover some of the riskier assumptions hiding behind your retirement estimates and will provide 5 simple steps to help address these problems.
How Retirement Calculators Work
At some point in your life the question will arise, “How much money do I need to retire?” You can either seek help from a financial professional (usually most advisable) or try to do the planning yourself. If you do it yourself, usually at some point you will use some sort of online retirement planning calculator.
Once you enter the required figures and estimates to the calculator, a computerized logarithm calculates and projects your future investment growth and expenses based on the set of assumptions you used for inputs. Examples of data you might need to know and enter are your anticipated retirement age, life expectancy, projected inflation, investment return assumptions, portfolio size, and probably retirement expenses. Some calculators will use more information, and some will use less. At the end of the day, though, math is math.
The Assumptions are Critical, Not the Calculator
People sometimes wonder, ask, or argue about which retirement calculator is best. However, that is usually not the most important issue. Usually, the critical factor to the accuracy of your retirement estimate is the assumptions used to get this estimate. For example, the investment return assumption. Most assume that what happened in the past is what you should expect in the future.
If (and this can be a big “if”) future investment returns resemble the past, then your assumptions about investment return might be roughly correct. If not, then they’ll be all wrong.
What is your life expectancy? No one knows.
How much will you spend? It’s debatable. Many increase lifestyle spending in the early retirement years while health and endurance to enjoy an active lifestyle is still high.
Inflation is based off of recent history. Yet, even those estimations are not always reliable due to factors such as fluctuating government debt, entitlement programs, and even the influence of unexpected national expenses such as bank bailouts. It’s difficult to “guess” the future of inflation.
All-in-all, as financial professionals, we highly recommend using a trained and experienced financial professional when accuracy regarding financial decisions matters. And in few areas of life does such accuracy matter than when creating a financial strategy for retirement. However, if you do find yourself using financial calculators – even just to get a vague idea regarding your retirement financial figures – then below are some tips to help make doing so a more beneficial experience.
5 Tips for Using Retirement Calculators
- Never let the projected amount needed for retirement mislead you. It may not be accurate. If any assumptions are incorrect, the estimate will be respectively wrong.
- Don’t just calculate a retirement savings goal once and forget it. Periodically review your input and calculations to see which assumptions prevailed and which ones didn’t. Then, adjust your future assumptions as needed and recalculate.
- Remember that errors multiply. Small errors in estimates can lead to large errors in results. For example, a 2% error in inflation over 5-10 years can have far-reaching implications when compounded over 30-40 years. Small details can make a world of difference, so pay close attention.
- Perform scenario analysis. Use these convenient retirement calculators to test various scenarios. As you apply more scenarios, it becomes apparent what might work for your situation.
- Calculator users quickly see how real return, net of inflation, is a number that matters BIG after a few scenario tests. The importance of time in compounding the way to wealth, versus trying to save the way to wealth, is also a relevant concept to pay attention to when performing calculations.
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