"Do you want to be able to maintain your standard of living in your golden years? Do you want to make sure you don’t run out of money before you run out of time? Do you want to know how much money you’ll need to make that happen?” . If you answered yes to these questions, then the only way you can find the answers is to calculate the number. Anything less is a guess!!
Just the act of planning and setting goals has a benefit. Even if the goal isn’t accurate, it just has to point you in the right direction, because having goals is a necessary condition to reaching them.
And there’s another benefit in trying to work it out. Research shows that nearly 50% of those who go to the trouble of calculating their retirement numbers end up taking some sort of positive action to improve their situation.
It can certainly be a wakeup call.
There are any number of retirement simulators that you can use. Your super fund almost certainly has one on their website.
Alternatively, the Government’s ASIC Money Smart website is a great resource - bookmark it on your browser.
The AMP Retirement Simulator is a beauty too.
Vanguard have an excellent Retirement Nest Egg calculator that uses quite a sophisticated “Monte Carlo” calculation.
Now, what I’m about to say may sound crazy and completely contradictory
Despite all their fancy calculations, the answers your chosen simulator will provide will only ever by an educated guess.
Yes, that’s right. And a guess at best. At worst, they can be downright misleading.
You see, behind all that sophisticated computer modelling are a lot of very big assumptions about investments, the economy and even when you might die!
So unless you have a crystal ball, you can’t possibly know how long you’ll live, what inflation will be, what the government is going to do with Social Security or what will happen with investments markets over the next 30 years.
Change one of these inputs, even a little, and the amount you need to save for retirement will change dramatically. Here’s a simple example:
$1 invested at 10% for $30 years is $22. That same $1 invested at 9% for 30 years is worth just $14
A 1% change in the return assumption has changed the end result by 60%. Wow!!
Think about that for a minute, because it’s no small problem.
Just to be clear, the formulas that support the various calculators will be fine. In fact, some are very sophisticated. “Monte Carlo” simulators compare thousands of possible scenarios to provide you with a probability of success. Other highly respected calculators “backcast” using actual investment market history, while simpler versions apply averages.
Will the results produced by each variation be different? Probably, but surprisingly, not by much. If you use the same assumptions, you’ll get roughly the same result.
The important thing is not the calculator you choose but the assumptions you choose for the calculator.
They certainly are convenient though. Your simulator will provide you with a really simple answer to a very complicated question (supported by plenty of disclaimers).
Unfortunately, while being mathematically precise, they are not accurate. They can’t be. It’s impossible.
The reality of retirement planning is that it’s not the science you (or me) would
Let me be clear. I don’t oppose the use of calculators - only the misuse of them. They are super valuable tools when used correctly.
After years of working with these things, I’ve come up with Five Tips to help you get the most out of using them.
Tip Number 1 - The Map Is Not The Territory
Never kid yourself into believing your retirement estimate is accurate. The answer is baked into the cake by the assumptions chosen. If the assumptions are wrong, so will the estimate.
Tip Number 2 – It Is Never A Once Off
Never perform the exercise just the once, put it on a shelf, and forget about it. Instead, check back every year or so and see what assumptions proved valid and which ones didn’t. Adjust the assumptions if need be, recalculate, and shift your plans accordingly. Keep repeating every year or so. This way you’ll hit your retirement target like a rocket that must constantly correct course to get to its destination.
Tip Number 3 – Errors Multiply
Small errors in estimates compound into large errors in results, so it pays to be conservative. Retirement savings are built and spent over multiple decades. A 1% error in investment return won’t make a huge difference over 5 to 10 years but can be a complete disaster when compounded over 30 or 40 years. Small details make big differences, so pay close attention to the details.
Tip Number 4 – Evaluate, evaluate, evaluate
Where these simulators really shine is they allow you to evaluate all kinds of potential options. Watch what happens to your retirement nest egg when you increase savings. Look at the net effect of something important like working a few more years, downsizing your house, or even selling your business. See the ongoing result of increased spending or gifts to your children or your favourite charity.
Simulators help you visualise the cause and effect of your financial decisions, not just for today but throughout your entire lifetime.
Tip Number 5 – Learning
The wealth created through simple financial strategies like compounding and regular savings is too often underestimated. But when you see the massive impact they can have on your own numbers, these concepts are much easier to grasp, even for the laymen. Each lesson learned will improve the way you manage your money.
So there you have it. As tools to plan, test, compare and hypothesise, simulations are ultimately necessary and extremely useful.
Just apply them properly with a clear understanding of the limitations.
IMPORTANT- This information is shared with you purely for the purpose of financial education. It is based on generally available information and is not intended to provide you with specific financial advice or take into account your objectives, financial situation or needs. You should consider obtaining financial, tax or accounting advice on whether this information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. See full Terms and Conditions here.