Understanding Retirement Calculators

Retirement Calculators

Can you predict the future? That's what a retirement calculator attempts to do. 

 

 

The Two Predictions

A retirement calculator makes two predictions:

Retirement calculators may vary the approach in answering these questions, but ultimately these are the predictions you need.

Retirement calculators are a valuable tool. The better ones require a considerable amount of information. However, just because you have provided a lot of information does not guarantee a good prediction. Like many tools, retirement calculators have their limitations.

Why can the predictions be wrong?

Both predictions involve long periods of time. This makes the prediction very sensitive to factors which must be assumed. These factors include:

Just to make things more complicated, most retirement calculators use average values. As shown in the illustration below,an average value can yield a wrong answer even  if the average is correct!

A $10,000 dollar 20 year investment at 10 percent average annual return

Case 1: Return is 5 percent for 10 years, then 15 percent for the next ten years. The average is 10 percent

Case 2: Return is 15 percent for 10 years, then 5 percent for the next ten years. The average is 10 percent

Start: 10,000.00 10,000
Year 5: 15,969.19 17490.06
Year 10: 32,119.74 35,178.76
Year 15: 49174.01 44898.01
Year 20: 62759.98 57302.50


If the investment return had been 10 percent every year, at year 20, the investment would be worth $61159.09. The actual results vary depending on the year to year returns making up the average.

The illustration shows three different answers even though the average number is the same in all three cases. And this is the result of just one of the factors needed to get the result. With so many factors to predict, and considering that the factors themselves may vary, the predictions of the retirement calculator are subject to considerable variation. 

What can be done about these problems? 

Awareness of the uncertainties is a first step in addressing them.

First, be conservative in your assumptions. This means selecting factors in a way that yield a result with some padding. Chose a lower rate of return than the best rate of return. Chose a higher inflation rate. And so forth.

Second, use the retirement calculator to experiment with changing the factors to determine how much the predictions are impacted. This allows you to determine a high and a low value to bracket the prediction. 

Third, periodically review the factors used as input to the retirement calculator. Also, review where you are relative to the predictions of the retirement calculator. Hopefully you have used a calculator which provides an answer showing where you should expect to be at the end of each year.

Fourth, consider involving a professional. A professional can help you select realistic yet conservative factors for your assumptions. A professional can help interpret the results. A professional can provide the periodic review and update of the results. And a professional should be aware of any changes in the laws which might impact your results.

A retirement calculator is a valuable tool for long term planning. As with any tool, there should be knowledge of how to apply the tool and and understanding of its strengths and weaknesses.

For your convenience, here are some retirement calculator available on the World Wide Web.

http://www.quicken.com/retirement/planner/
This planner is part of the overall Quicken site. The site includes a variety of financial and investing information.

http://financenter.com/retirement.html
This planner is part of the overall financenter.com site. This site offers information on a variety of financial concerns, even helping to find low rate credit cards.

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