The point: retirement calculators are only as good as the information you put in them and the underlying assumptions of the calculator itself, and are useful only to model the future, not predict it.
The lure of the retirement calculator is that it will tell you your future; you’ll punch in your age, how much money you’re saving, and when you want to retire, and when you hit the calculate button, the computer will say “Winner! Gagnant!”, and you’ll realize you don’t have to save anymore.
Maybe that’s just me. See, I play with retirement calculators pretty often. What I’ve observed in my years of tinkering with even the best ones is this: garbage in, garbage out. (Welcome to the world’s Most Obvious Awards.)
Remember last February, when you went to the bank to make a contribution to your RRSP? You sat down with someone in an office and did some retirement planning, and you left with a printout from the retirement calculator and an RRSP contribution receipt?
Which one of those pieces of paper did you keep?
I know, it’s a silly question. You kept both. You kept the receipt for your taxes and dutifully filed away the printout. I bet if you looked in your filing cabinet right now you’d find it, tucked in with all the other paper flotsam you feel like you should keep but don’t really know what to do with.
You kept it because you have a deep desire to understand what is likely to happen in the future and to be able to plan for it. You want to be able to make your next financial choice (and the next one, and the ones after that) knowing as much as you can about the possible outcomes of that choice.
Here’s the bad news: the advisor you sat down with when you contributed to your RRSP last February used a retirement calculator exactly like the one you can use yourself online, and there’s only a very slim chance that the retirement income he forecasted for you was right.
To be fair, realistically forecasting your future income from government benefits, private pensions, and personal savings is complicated, as is predicting how much you’ll be able to save, what taxes you’ll pay, what inflation will be, and when you’ll actually stop working – if you do.
To be really fair, the further away you are from that future, the harder it gets to predict.
To be really, really fair, if you don’t know how to do it, or don’t acknowledge the basic faultiness of the whole concept of “calculating” your retirement, then you can’t call it retirement planning.
Look, for a lot of people, saving money is enough. They put money in an RRSP or TFSA (or both) and don’t spend a lot of time trying to predict the future. Frankly, they’ll probably be fine. As they get closer to the age when public pensions kick in, they’ll adjust their expectations to match their increasingly accurate (because it’s closer) future. That’s what humans do.
But what if you have big dreams? Or you recognize that “just saving” is a risky course of action, and want to identify and mitigate those risks? What if you want to make the best financial choices you can with the best information available to you? “Just saving” isn’t going to cut it for you, and so you plan.
That printout isn’t going to guide your financial choices because you don’t really understand what went into creating it. Now, please understand, what follows isn’t going to guide your financial choices, either. It can only get you familiar with the concepts and assumptions of the standard retirement planning process.
The easiest and best place to start with retirement planning – and most things in life – is with the facts. Your age, how much you have in long-term savings, and the minimum amount of money you need to pay your necessary expenses (which is usually expressed as a percentage of your current after-tax income).
The (Educated) Guesses:
When we talk about things like inflation rate, rate of return, likely income from guaranteed sources, and length of retirement, we’re already in crystal ball and tea leaves territory. These are the things we can’t predict with precise accuracy and have no control over. Yes, we can talk about historical numbers and statistical probabilities, but no one really knows what’s going to happen. You don’t know how long your retirement will last because (newsflash) you don’t know when you’re going to die.
By default, then, conservative folks will use the highest reasonable numbers for inflation (like 3%), lowest for rate of return on a balanced portfolio* (5%), and longest for “length of retirement” (95 or even 100). This number will scare you, and it’s supposed to. It’s meant to express the amount of money you need to have in the worst case scenario.
How much you save and when you retire are two things you do have control over, which is why they’re the first numbers to get played with. Most people are looking to retirement calculations to either A) verify that they’re saving enough, B) tell them how much they should be saving, or C) figure out when they can retire, or quit their job forever (not necessarily the same thing, as +Jon Chevreau would say.)
There are some excellent free retirement calculators out there, for the purposes of this exercise. +Rob Carrick wrote a great roundup in 2011, and I agree with his assessment that by far the best one to use is The Canadian Retirement Calculator from Service Canada, although it has its weaknesses: it doesn’t take into account the Child Rearing Dropout Provision and gets increasingly wonky if you start trying to calculate earlier than 65 retirement numbers.
The Optional Tools for Real Money Nerds:
Even though +Darrow Kirkpatrick‘s roundup is for Americans, you can still play around with them (the calculators, not the Americans) if you’re feeling confident. My particular favourite to use in conjunction with Service Canada’s calculator is the Vanguard Retirement Nest Egg Calculator, which – given the size of your savings when you retire, your asset allocation between stocks, bonds, and , the number of years you think you’ll live, and the amount of income you’ll need after public and private pensions – will run 5000 historical market scenarios and give you the probability of your nest egg lasting until you die, no matter what the markets do.
Start easy. Use conservative numbers and an easy to calculate retirement age of 65**. Figure out first what kind of income you’ll have if you continue to save exactly as you are now, and your existing savings continue to grow at conservative rates.
If that number doesn’t satisfy you, start tinkering. Decrease the amount of income you’ll need (you might work a part time job in retirement), increase your savings rate, or push back your retirement age.
For fun, figure out how much you should save in order to semi-retire at 50 and work for less pay doing something you’ve always wanted to do.
You’ll be tempted to increase the rate of return and decrease the rate of inflation – I know I always am. If my portfolio earns 15% net of fees and inflation is 1% in the next 15 years, I’ll only have to save another $25 a month to see myself retired at 49, reading books on my porch. (A girl can dream.)
Once you start playing around with the numbers, you’ll get the creeping feeling that you don’t know anything and it’s impossible to tell the future. That creeping feeling is right. Retirement calculators aren’t solving a complex equation that will exactly predict your circumstances provided you just put the right information in. They’re all just models, potential futures that probably won’t happen the way you expect anyway.
That doesn’t mean that you shouldn’t go through the exercise with gusto, because unless you want to “just save”, having a plan – even one that has an overwhelming statistical probability of not working exactly as you envisioned – is essential in order to make informed financial choices throughout your life.
If it doesn’t inspire you to think more deeply about your own retirement assumptions, then at the very least, it should help you evaluate if the salesperson you’re sitting across from knows what he or she is talking about the next time hunting RRSP season rolls around.
Whew! We’re almost done with this series – and good thing, too, because I want to write about mutual fund fees, or embedded commissions, or anything other than retirement, really.
If you’re just starting with me, you can read the rest of the series here:
- RRSPs: Hunting Season (what banks and brokers are really offering at RRSP season)
- Avoiding the Useless Retirement Plan, Step One (figuring out what you mean by “retirement”)
- Numbers, Numbers, Numbers (how to calculate exactly what you’ll spend in retirement by figuring it out today)
- Incoming (how to predict your retirement income from public and private pensions)
- Effective Retirement Planning is About Spending, Not Saving (And Sit Up Straight) (what to do if you can’t save enough)
My next (and last) post of the series will help you work out an action plan for the three possible outcomes of Fun With Retirement Calcuators: you aren’t saving enough, you’re in great shape, or you don’t know what the hell you’re doing.
*I’m sure you’ve heard the term “balanced portfolio” before, especially if someone ever geeked out over an Andex Chart in front of you. Generally speaking, it’s financial short form for a portfolio that has the classic 60%/40% split between equities and fixed income (held directly or as mutual funds or ETFs)
**Most Canadian calculators still default to retirement at age 65, which will gradually change to 67 as changes to Old Age Security are gradually introduced.