A Cautionary Tale About Retirement Calculators

How comfortable would you be if you knew that the online retirement calculator you used failed to muster a passing grade? Well, according to Texas Tech University researchers, that’s exactly what they found

In a recent study, researchers tested 36 online retirement tools, including those from major players like Vanguard Group, Fidelity Investments, T. Rowe Price Group, AARP, the Financial Industry Regulatory Authority (FINRA) and others. The research team, which included well-known industry veteran Harold Evensky, found only 11 of the 36 to be worthy of a passing grade. The team cited overly simplistic tools as one of the main reasons for its harsh assessment. (For related reading, see: 4 Best Personal Finance Apps for 2017.)

Issues Such Tools Ignore

For example, most of us are aware that healthcare costs have been rising faster than overall inflation, yet many calculators ignore the issue, which can have major consequences on retirement planning. The average person who has smoked throughout adulthood has a six and a half to 15-year shorter life expectancy than a non-smoker. This point alone can have major implications on retirement planning.

In our opinion, even robust retirement tools are fraught with irregularities. All of these tools require assumptions about things like returns, inflation, life expectancy, income and expenses, to name a few. As well intentioned and rigorously researched these assumptions are, they still remain, well, assumptions. Case in point, the average annual return for the S&P 500 over the last 87 years has been 9.5%. Over the last 50 years, 9.61%. The average would imply an assumed 9.5% return for stocks is reasonable, yet, over the past 87 years care to guess how many times the S&P actually returned 9.5%? If you said zero, gold star for you! (See chart below).

So, why does it matter, if returns still average out to 9.5%? We end up in the same place, right? Actually, no. And it is because of the sequence of returns. The sequence has big implications when it comes to retirement planning and, unfortunately, cannot be pre-determined. Experiencing lower than assumed returns in the first few years of retirement can have major negative implications. Above average returns also change the calculus. So what do you do? (For related reading, see: Why Retirement Plan Sponsors Could Face Litigation.)

With a fail rate of almost 70%, results from online calculators should be taken with a healthy dose of caution. Calculators can provide directional consistency, however for a truly rigorous analysis turn to your financial advisor, who typically, has more comprehensive and detailed software at his/her disposal. Advisors are also subject to assumption irregularities; the difference, however, is a good advisor adapts and adjusts as actual results tip the assumption scale in one direction or the other. This is where the rubber hits the road and where an advisor’s value can really shine

Similar to driving direction websites like MapQuest, retirement calculators can show you how to get from one place to another, but can’t adjust for unpredictability. Without more data, like real time traffic updates, you could find yourself sitting in a traffic jam as you make your way across town.   The same could be said for retirement calculators. Without robust planning tools and consistent monitoring, your favorite retirement calculator could be taking you down the wrong road. (For related reading, see: Youth and Roth IRA Equals a Solid Retirement Plan.)