Many personal finance sites, as well as banks, brokers, and accounting pages feature retirement and goal planning calculators. These tools are certainly useful, but with caveats.
If a 35 year old person in the early stages of their career uses such a calculator to frame the numbers around their own projected retirement ~ 30 years later, how likely is it that the numbers turn out to be accurate? A reasonable set of assumptions to plug into such a calculation would include (not exclusively):
It should be obvious from the list that there are a lot of variables in this math! In some ways, making accurate predictions about a person's financial condition decades from now is like landing a jet on an aircraft carrier at night, in the rain, and no assistance from the control tower.
This is not to say that the calculators have no value; in fact, this sort of tool is very helpful in starting deeper conversations around financial planning and managing expectations around goals. Our hypothetical 35 year old (or 45 year old!) should take the time to run the calculations, but should take care with the results...any slight tweak in one assumption or three will make dramatic changes in the final numbers. And if there is any one thing certain in life, it is that life can be very uncertain!
Below the jump I will share one very simple example of how even slight volatility in assumptions can impact results.
Let's consider two examples of a 20 year accumulation goal. In both cases, the investor begins with $10,000, wishes to grow that amount in a manner consistent with the risk and return of the S&P 500 equity index. The only difference in the two situations is the particular 20 year period.
Sample data #1: 4/11/1988 to 4/11/2008 (using the S&P 500 total return index, which includes dividends), the chart shows a 20 year net change in value of 677.3%
Sample data #2: 4/11/1993 to 4/11/2013, the chart shows a 20 year net change in value of 425.4%
So what does that mean for our two scenarios? In both cases, our hypothetical investor has the same time horizon and risk tolerance (defined very simply here as "20 years" and "consistent with the S&P 500"), but has very different outcomes. Scenario #1 leads to a final dollar amount of ~ $67,700; scenario #2 finishes the 20 years at ~ $42,540.
It is impossible to know in advance what the next 20 years will bring, and in the case of these two samples, it is apparent that the range of possibilities is wide. Even with two "positive" examples as these resulting in significant gains, there is a difference of $25,000 in final money!
A robust and holistic financial plan will not erase all of that uncertainty, but a well constructed plan could provide some cushioning in expectations, or otherwise build in some factors of safety around the retirement planning assumptions.
David R Wattenbarger, president of DRW Financial
FCL LLC (“DRW Financial”) is a registered investment advisor offering advisory services in the State(s) of TN, GA, IL, OK and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by DRW Financial in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant to an applicable state exemption.
All written content on this site is for information purposes only. Opinions expressed herein are solely those of DRW Financial, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.