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Can you trust a retirement calculator?

Retirement calculators seem to be popping up everywhere, and people are betting their financial future on them every day. Unfortunately, the calculators are often giving fictitious outputs based on assumptions that have little to no chance of being accurate.

Here are six reasons you can’t trust retirement calculators, and what you can do to ensure you’re getting the best predictions for a secure retirement.

1. Differences in calculations

Calculating how much you’ll need in retirement is a surprisingly complex thing to do. That’s because it’s subject to a wide variety of different results, depending on the figures used when making the calculations.

As a recent NZ Herald article quite rightly pointed out, just calculating how much you’ll have when it comes time to retire – which is just one part of the calculation – can produce some extreme differences in results. For example, it was reported that a 20-year-old in a growth KiwiSaver fund could have anywhere between $459,000 and $1.36 million depending on the calculator used! This is because the output (or results) obtained from any retirement calculator is only as accurate as the assumptions used for input (used in the calculations behind the scenes that you don’t get to see). The wide variety of different assumptions that can be made about such a scenario include: inflation, investment returns, contribution rates, income, and tax. Also note that the NZ Herald article only focussed on the lump sum available at retirement – even more difficult is reliably calculating someone’s income for the duration of their retirement.

Because differences in the calculations will become more amplified over time, predictions become more challenging based on your age. This is because the effect of the inputs used is compounded over time, turning small errors into big problems. This is the reason for the huge variation in results when calculations are made for someone who is only 20-years-old. Although admittedly, most 20-year-olds we come across have plenty of things on their mind other than retirement!

While no one can know many things for certain, retirement calculators require you to make an educated guess anyway. For example, let’s consider just three of the many assumptions that are made:

  • Investment returns.The conventional wisdom is that future investment returns will relate in some way to historical investment return, or in other words, what happened in the past is what you should expect in the future. Of course, this couldn’t be further from the truth.
  • Another area is inflation, which also can’t be estimated for 30+ years into the future with any degree of confidence or accuracy. Even so-called experts struggle with forecasting inflation over much shorter terms. This is incredibly important because small changes in the inflation assumption will produce dramatic changes in your retirement savings needs.
  • Other income sources.Some retirement calculators may not factor in government superannuation, or other benefits for those fortunate enough to have them – such as GSF (Government Superannuation Fund).

To avoid the issues with assumptions, you should avoid retirement calculators that limit your flexibility to change assumptions. The most obvious example is any calculator that has a built-in investment return function based on how investment markets have historically performed. This is especially the case over the last 10 or so years, as investment returns over that period have been much higher than most commentators expect over the next decade.

2. They cause complacency – when the calculator shows you’ll receive a huge sum

Quite incredibly, many of the calculators available online don’t account for basic things such as tax or inflation at all, or, worse still, assume a whopping return on investment that’s highly unlikely over the long-run. Some even use a figure of 10 percent investment growth after all fees and taxes, which is never going to be realistic.

Of course, the result of incorrect inputs is the calculator telling you you’ll receive a higher retirement income than can realistically be expected. This usually leads to complacency, and if that complacency leads to inaction, the results for a happy and wealthy retirement could be dramatic. This is another reason that retirement calculators can’t be trusted.

3. They cause worry – when the calculator shows you’ll receive a smaller sum than expected

The opposite of the situation described above is when people are stressed and anxious they won’t have enough to fund the retirement they want. While it pays to be at least a little conservative when making retirement planning assumptions, some retirement calculators are overly cautious in their assumptions. This leads to lower overall returns, and a lower overall retirement income being displayed as a result. While this may be motivating for some, this can be very stressful for others.

For those who try a few different retirement calculators, in some cases this worry may lead people to invest with product providers whose calculators show they will achieve the highest returns! Clearly, this is not always the best course of action, and is entirely based on some incorrect assumptions put into the calculator giving a potentially misleading result.

4. Many retirement calculators are just sales tools

Often, a largescale provider of investments will simply have a retirement calculator tool that will always conclude you should invest in that provider’s product, regardless of the scenario that is put into the retirement calculator! In these cases, the ‘retirement calculator’ is just a sales tool that suggests you invest funds regardless of your goals, situation, or attitude towards investments.

To solve this issue is quite easy, as a good financial adviser (especially like those at Milestone Direct, who are paid a salary and don’t receive commission of any kind) will often recommend people don’t invest any surplus sums – for example, perhaps paying off their mortgage is a better idea.

5. People don’t use retirement calculators to analyse different scenarios

Retirement calculators are fantastic tools for comparing the impact of various retirement planning scenarios, even if most people don’t use them this way. To make best use of a retirement calculator, different scenarios need to be tested. For example, should you try to invest your way to retirement with a ‘traditional’ portfolio of investments, or pursue real estate investments as another component to the plan?

To make the best use of retirement calculators, test both scenarios and see what the numbers indicate. Other questions to answer could include:

  1. How would a part-time business affect your retirement income needs?
  2. What happens if you convert your career into a period of consulting or part-time work for a few years of semi-retirement, then retire fully?
  3. Can you afford to leave a financial legacy to your children or grandchildren many years before you pass away?

As you get creative applying various scenarios, it usually becomes clear what’s best for your situation.

6. People don’t use them enough – you need to repeat the process

Don’t perform the retirement planning exercise once, put it on a shelf, and forget all about it.

Instead, check back every year and see which assumptions proved valid and which ones didn’t. Then, recalculate and shift your plans accordingly. While it can be tempting to adjust many of the assumptions made with the calculations, it’s generally best not to – this is because you’ll be tempted to adjust long-term assumptions based on short term results. For example, just because you had a great investment return in one year doesn’t mean that this will be repeated year-on-year over the long run.

Recalculating and adjusting your plans each year is the surest way to hit your retirement goal. You’ll be just like a guided missile that constantly corrects its path toward its target.

The bottom line

Retirement calculators are valuable tools when used properly. However, every day, people are betting their financial future on fictitious outputs based on assumptions that have almost no chance of being accurate. Let’s recap the key issues with retirement calculators:

  1. Differences in calculations
  2. They cause complacency – when the calculator shows you’ll receive a huge sum
  3. They cause worry – when the calculator shows you’ll receive a smaller sum than expected
  4. Many retirement calculators are just sales tools
  5. People don’t use retirement calculators to analyse different scenarios
  6. People don’t use them enough – you need to repeat the process
This article has been contributed by Joseph Darby, CEO and authorised financial adviser at Milestone Direct Ltd. This article first appeared on the Milestone Direct website. The views and opinions expressed in this article are those of Joseph Darby and not necessarily those of Milestone Direct Ltd. The views and opinions expressed in this article are intended to be of a general nature and do not constitute a personalised advice for an individual client. A disclosure statement relating to Joseph Darby is available, on request and free of charge.

About Milestone Direct Ltd

Milestone Direct Ltd
Milestone Direct Ltd is a full-service financial advice firm with a focus on retirement planning, wealth management, and ensuring your funds don't run out before you do. Milestone Direct is unique, with; no product provider ownership, no quotas, and all financial advisers are paid a salary instead of commission. Milestone Direct Ltd are already trusted as the official financial advice provider to organisations such as the NZ Defence Force, so you can trust them too. Call now for a free and no obligation initial consultation, toll-free 0508 645 378 or learn more at: www.milestonedirect.co.nz.

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