Beware the Online Retirement Savings Calculator
I love a good tool in my financial toolbelt. I’m open to all kinds of well-researched tips and tricks that will help my clients better understand a particular financial concept, or perhaps remember the parameters separating a Roth IRA from a Roth 401(k).
Therefore, I’ve found myself turning to a series of financial calculators in the past. While some of them are excellent, others are gravely inaccurate and could lead you down the wrong path. One of the biggest advantages of working with a financial advisor throughout the year is the ability to avoid making major financial mistakes. So here is what I’ve learned when evaluating retirement savings calculators.
The fewer unknown variables, the better.
Tools that calculate a home down payment percentage, future monthly car payment, amortization schedule, etc. are nothing more than a simple math equation. The program is set to include a limited number of known data points and therefore you can have confidence in the results. Alternatively, be weary of calculators that attempt to project your future retirement savings or determine how much you need to be saving toward your child’s education. There are a series of assumptions being made and each one can have a dramatic impact on your results.
Review the underlying assumptions.
Never trust a calculator that spits out answers without clarifying what data inputs are being utilized. Retirement planning calculators make assumptions about your future savings rate, future inflation rates, future investment returns, future pay raises, life expectancy and more. None of us are privy to this information, even financial advisors! What other assumptions are at play in the calculator you’re using? Can you customize the answers? If so, would you even know what selections to make?
Savings rates are rarely consistent.
Most of us will find throughout our lives that our ability to save and invest wax and wane over time. As life introduces new adventures and new complications, it’s rare to see a client that has maintained a consistent contribution rate throughout their entire working career. Yet a steady savings rate is assumed by just about every retirement planning calculator on the internet.
Lump sum goals not accounted for.
Retirement income calculators typically plan for your living expenses only. They ask, “how much annual income will you need in retirement?” What about lump sum goals like travel, home repairs, and gifting? And not so fun expenses like major long-term care expenses if your health starts to decline. Thanks to these additional expenses, you may find there are certain years you’ll withdraw more from your portfolio. Your income will not likely stay consistent throughout your entire retirement timeline. How is that reflected?
Their investment return assumption vs. your expected portfolio return.
Mint.com has a goals feature where you can create a retirement funding goal. It lists two customizable assumptions used in the software (inflation rate and life expectancy) and only required a few areas of input from me. What’s most alarming is the section that asked for my investment style. I currently fit into the aggressive growth style (listed as 9% return), but like any prudent investor, I will shift into a more conservative allocation later in my career. It appears that Mint is assuming a 9% return throughout my entire plan. I cannot find any information that lists the underlying assumptions of the calculator, but here’s why I think that: My mint results claim I’m set to retire prior to age 50, with a nest egg of $3 million, if I maintain half the savings rate I’m doing right now.
While I am flattered and certainly wish that feedback was accurate, that simply isn’t the case. I’ve run a customized financial plan for my family and found my results to vary dramatically from that calculator.
Financial calculators are tools created to answer a specific question and improve financial literacy. They often play a juggling act between requiring minimal data input from users while attempting to generate accurate results in sophisticated areas of financial planning. Karl Ebert has created more than 450 online calculators that are licensed to popular websites and financial institutions including AARP, Navy Federal Credit Union, American Funds and Bankrate. He’s been building digital calculators since 1998 and his tools are featured on more than 10,000 financial websites.
When interviewed by CNBC two years ago, Karl said: “Financial calculators give users a good ballpark answer. When they want all the pieces lined up in the puzzle of financial planning, they should bring in a professional.”
Consider, do these calculators help you take action? Motivate you to increase your current contributions? Keep you on track with executing your plan? If our brains are hardwired to make lousy financial decisions, do they keep these biases in check?
All tools have limitations. Now you can look out for these potential pitfalls!