One online calculator tells this reader he's on track; another tells him he needs to save half his salary from now until the day he retires. Which should he believe?
We all hate something. Almost everybody hates taxes. My wife’s family hates the Red Sox. Me? I hate online calculators.
For a textbook example of why, here’s this week’s reader question:
I checked the calculators you provided in your recent article “8 Reasons Your Parents Had an Easier Retirement Than You Will.” AARP said that I was over target, Bloomberg had me right on, and the FINRA calculator said that I needed to save 50 percent of my income every year from now on to make my target.
How do we validate that the information we are getting is accurate? There is no lack of information … but when they do not agree, how do we find what is good information? — Kenneth
I’m not surprised Kenneth can’t find an online calculator he can count on. Here are the reasons I’ve grown to hate many types of online calculators.
1. They ask you to know the unknowable
In order to provide answers to money-related questions, many online calculators require that you first provide very specific predictions for future events. The problem with this is twofold. First, they often require predictions that even experts can’t possibly know. Second, because many of these calculations occur over decades, the slightest variations will produce radically different results.
One of the calculators we suggested in our recent article serves as the perfect example of this common weakness.
When we compare these calculators, we see the first two are straightforward. You tell them how old you are, how much you intend to put aside annually and how much you expect to earn on those savings. The calculators then tell you how much you’ll have at retirement age. The FINRA calculator, on the other hand, requires that you answer additional questions. They include the inflation rate from now till you retire, the tax bracket you’ll be in when you retire, what annual income you’ll need in retirement, and at what age you’ll stop withdrawing from your savings, which I assume is a roundabout way of asking when you plan to die.
There’s not a person on this planet who can know any of these things, or even hazard a reasonable guess, especially if your retirement is decades away. And even the slightest variation in variables, such as how much you’ll earn on your savings or the rate of inflation, will yield radically different outcomes.
A few years ago I wrote an article called “Which Is Better — Renting or Owning a Home?” In that article, I discussed a calculator offered by The New York Times that asks you to provide the percentage that housing prices, rents and property taxes, among other things, will increase or decrease years into the future. This is madness. If you know those things, you should be talking on CNBC, not filling out online calculators.
2. They’re the Wizard of Oz and you’re Dorothy
In a book I wrote years ago called “Money Made Simple,” I suggested a simple way to figure out how to divvy up your long-term savings. Here’s the formula:
- Step One. Subtract your age from 100 and put the resulting percentage into stocks.
- Step Two. Divide what’s left equally between bonds and cash.
So if you’re 20, you’d have 80 percent in stocks, and 10 percent each in cash and bonds. If you’re 80, you’d have 20 percent in stocks, and 40 percent each in cash and bonds.
I compared this basic technique with an asset-allocation calculator from a well-known financial website. Here’s what its calculator required as inputs:
- How much money you have now in various types of investments
- Your tax bracket
- How much of your savings you intend to spend within two years
- How much you intend to spend within 10 years
- How much you intend to leave to your heirs
- Years to retirement
- How much of your savings is in tax-deferred accounts
- How much equity you have in your home
- How many dependents you have
- Your volatility tolerance
- Your economic outlook
- Your inflation forecast
So how did the results of this super-sophisticated calculator differ from those of my super-simple method? To find out, I assumed a 35-year-old and tried to pick middle-of-the-road answers for the calculator. The results:
- My take-your-age-from-100 method: Stocks, 65 percent; bonds, 17.5 percent; cash, 17.5 percent
- Wizard-of-Oz calculator: Stocks, 64 percent; bonds, 18 percent; cash,18 percent
Why would someone make a calculator so complex when something simple you can do in your head does the same thing? Because its creator wants you to think they’re smart and you’re not. Why? One reason might be …
3. They’re often used to sell stuff
One of the more notorious types of online calculators are those purporting to tell you how much life insurance you need. These calculators are often sponsored by sites that sell life insurance and, coincidentally, often suggest purchasing tons of it. As a result, they don’t include things like money your heirs might receive from Social Security survivor benefits. And they nearly always assume that you “need” to leave a nest egg large enough to support your spouse and kids indefinitely on the interest alone.
If you want to know how much life insurance to buy, don’t ask an insurance salesman, or a calculator from a site that benefits from the sale of insurance.
4. They give you a false sense of security
Calculators are comforting because they provide simple answers to complex problems. When you’re using a real calculator, the kind that multiplies 165 times the square root of 37, you get the same answer every time, and it’s the correct answer.
When you use retirement-forecasting and other types of long-term-planning calculators, you’ll also get a specific answer. But any similarity between that answer and the truth will be purely coincidental.
What should Kenneth do?
I wouldn’t dissuade Kenneth or anyone else from using online calculators. Just keep in mind that there’s an inverse relationship between predictions about the future and usefulness. In other words, the more you have to guess, the less useful the answer. And if you suspect that the site sponsoring the calculator has a commercial ax to grind, don’t even bother.
At the end of the day, the amount we should all put aside for retirement is the most we can. You don’t need a calculator to tell you that’s the sole determinant of the quality of retirement you’ll have and when it will begin.
Want to make yourself feel better, or worse, with affirmations from online calculators? Be my guest. Just don’t be surprised when the results differ or when they’re flat-out wrong.
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The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.
I founded Money Talks News in 1991. I’m a CPA and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate. I’ve been investing in both stocks and property for more than 35 years.
Got some time to kill? You can learn more about me here.