A pop-up appeared on my computer screen offering to calculate my “retirement number.” The message said it could tell me the amount of savings I’ll need to retire comfortably. I’ve seen these enticements before, usually offered by a well-known and highly regarded financial institution. Even the robo-advisors and their calculators are carbon copies of the industry’s accepted approach.
I don’t question the so-called Monte Carlo investment algorithms used to simulate market returns. What I do fault is the entire premise of extending that simulated market performance to individual investors’
personal retirement plans. An individual investor is not a pension or endowment fund with other sources to draw on, or with a virtually perpetual existence.
Here’s my list of observations about retirement calculators:
- Average investors don’t achieve average market returns. Multiple studies show that individual investors under-perform the market by significant margins. While the amount of underperformance may be in question, it seems clear that individual investors rarely have the patience or nerves to stay fully invested in the market during volatile times.
- Investor behavior changes when withdrawing rather than building savings. While there is very little research on how retirees behave when they are withdrawing their money rather than building up savings, it seems obvious (based on personal observation) that the prospect of a few years of cash flow before savings run out likely leads to a move to liquid savings. Further, the recent market volatility offers a good example of investor behavior under stress. Both of these situations involve a degree of panic.
- Calculators may project up to 30 years of retirement but don’t reflect higher late-in-retirement expenses. Uncalculated costs include unreimbursed medical, home health care or long-term care requirements that dramatically increase expenses — and that strain savings. The accepted average figure for unreimbursed medical costs is $250,000, but that soars to more than $600,000 if you project a couple living to age 95, according to a Society of Actuaries study.
- Calculators project a “likelihood” of success that is unmanageable. Say an investor’s number reflects an 80% chance of an investor’s savings running out at age 95. What should an investor do with that “success” ratio? To improve the ratio above 80%, an investor can reduce the number of years of retirement or the amount of money available to spend each year. Neither is a palatable option. And being more, or less, aggressive in the stock market is very unlikely to bring you to closer to 100 percent.
- Calculators rarely attempt to maximize spendable or after-tax income. Even at a modest combined federal/state tax rate of 25%, the results may be off by a factor of one-quarter. These calculators also often ignore any tax minimization strategy to keep the algorithm simpler.
- Calculators ignore the one financial product that can make things better – an income annuity. In fact, this singular product, offering guaranteed lifetime income starting on a date the investor elects, can help address the five problems stated above if properly integrated into a retirement portfolio. An investor can buy an income annuity that is immediate or deferred, qualified or non-qualified, and can purchase in a lump sum or in stages. Research based on your own circumstances will tell you which is best for you.
As with all financial tools that try to address uncertainty, which in this case means markets, lifespan and expenses, it’s important that you take a somewhat conservative view of the results. In particular, when you’re near or in retirement ask the provider to “stress-test” the results. Then see how you might “insure” yourself against some of the potential unhappy outcomes.