Photo (cc) by 401(K) 2012
Bankrate.com is a company that generates millions in revenue every year, so it’s a good bet they’ve done the research to find out exactly what people want to see on their website.
And what occupies some of the most valuable (upper left corner) real estate on the Bankrate home page ? Financial calculators. And not just a few, 12 different categories of calculators.
This tells me that those interested in personal finance really like calculators. Who can blame them? Finding a quick yes or no to life’s complex money questions is compelling stuff. But while one-minute solutions to all your financial dilemmas may sound attractive, in many cases the answers may not be as clear-cut as the word “calculator” might lead you to believe.
Here are five reasons I’ve grown to hate not all, but some, financial calculators.
1. They suggest people are simpler than they are.
As a CPA for more than 30 years, I appreciate more than most folks the appeal of reducing problems down to a single number. Unfortunately, life doesn’t often lend itself to that sort of linear thinking and finite conclusions.
From websites that promise to find your perfect mate to stockbrokers that offer to find your perfect investment mix, the process of inputting facts and outputting specific conclusions ignores something critical to many questions: how you feel.
An investment-mix calculator can tell you exactly how much of your savings to put into stocks, bonds, and cash, but few offer the ability to input how freaked out you’ll feel if stocks fall 50 percent, like they did in 2008 and 2009.
A lease-vs.-purchase car calculator has no input for the frustration of not being able to customize your car if you lease it, and you can’t explain how satisfying it is to live mortgage-free to a rent-vs.-own home calculator.
2. They suggest life is more complicated than it is.
Several years ago, I wrote a book called Money Made Simple. In it, I suggested a simple way to figure out how much of your long-term savings to invest in stocks: subtract your age from 100 and put the resulting percentage into stocks – then divide what’s left equally between bonds and cash. So if you’re 20, you’d have up to 80 percent in stocks. If you’re 80, you’d have 20 percent. But I also suggested modifying these percentages depending on how you felt about risk and basically just do what makes you comfortable.
Then I compared this ridiculously simple technique to the results provided by a relatively complex calculator from a financial website. Here’s what the calculator wanted us to input:
- How much money we have now in various types of investments.
- Our tax bracket.
- How much of our savings we intend to spend within two years.
- How much we intend to spend within 10 years.
- How much we intend to leave to our heirs.
- Years to retirement.
- How much of our savings is in tax-deferred accounts.
- How much equity we have in our home.
- How many dependents we have.
- Our volatility tolerance.
- Our economic outlook.
- Our inflation forecast.
Most people probably wouldn’t have even completed this calculator, since many couldn’t begin to provide all that information. But for those who did, below is how the calculator compared to my simple method. For both cases, I used a 35-year-old – for the rest of the calculator inputs, I tried to choose middle-of-the-road answers.
- Simple, take-your-age-from-100 method: stocks – 65 percent, bonds – 17.5 percent, cash – 17.5 percent
- Wizard-of-Oz calculator method: stocks – 64 percent, bonds – 18 percent, cash – 18 percent
Why would someone make a calculator so complex? Simple – because its creator wants you to think that they’re smart and you’re not. And why would they want you to think that? If they’re in the business of peddling financial products, to make money from you, of course.
3. They ask you to know the unknowable.
As in the silly calculator above, in order to provide a specific answer to your question, many online calculators insist that you first provide specific predictions for future events that nobody can possibly know. And the output will vary radically depending on your input.
Just last week I wrote an article for MSN Money called Which is better – Renting or owning a home?. In that article, I discussed a calculator offered by the New York Times that asked you to tell it the exact percentage that house values, rents, and property taxes, among other things, would increase or decrease four years into the future. My response? If you know that, you should be talking on CNBC, not filling out online calculators.
4. They’re often used to sell stuff.
The most notorious in this category: 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. They typically don’t include 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.
For my own safety, one of my strategies in the various marriages I’ve had is to remain worth more alive than dead – a concern I’ve never seen addressed by any insurance salesman or online calculator.
5. They give you a false sense of security.
As I said in the opening paragraphs above, calculators are comforting because they provide specific numbers to specific problems. When you’re using a “real” calculator – the kind that multiplies 165 times the square root of 37 – you get the right answer every time. That’s it – there’s no argument.
But when you start including the need to forecast the unforecastable or account for human emotions with a sliding pointer, the result you get may sway you into a stupid course of action due to the inaccuracy of your inputs. The calculator is always right when it answers a math question. But too many calculators are sending the wrong message by declaring a certain answer to an uncertain world.
Should you shy away from online calculators?
Absolutely not. They’re useful – especially when it comes to math. But consider adopting a couple of rules. First, the longer the time period under consideration and the more predictions you’re required to make, the less useful the calculator. And those offered by people trying to sell you something? Don’t bother – do a little research and do the calculations yourself.