Do retirement planning tools do more harm than good?
April 15, 2016
If you've thought seriously about retirement planning, you've probably seen them - any one of the dozens of automated retirement planning tools that are supposed to help you figure out how much to save for retirement.
A group of financial planning experts recently ran some tests which found that tools of this sort are highly unreliable. The only problem is, the number of variables these experts recommend using to yield a more reliable result may make the process of retirement planning seem too complicated for the average person.
This raises an important question: Is bad retirement planning advice worse than no advice at all?
The perils of bad retirement saving advice
The authors of the paper, entitled "The Efficacy of Publicly-Available Retirement Planning Tools," feel that bad advice is worse than none at all. Their concern is that by failing to account for all the relevant variables, people build a variety of blind spots into their retirement planning.
What's worse, the authors fear that using retirement planning tools will lull people into a false sense of security. They will believe they have a definitive answer on which to base their retirement saving program, and they may be led down the wrong path if that assumption proves to be wrong.
Factors of retirement planning
Here are the variables the paper recommends should be included in any retirement planning projection, grouped into five major categories:
- Age. This includes not just your current age, but when you plan to retire and your life expectancy, which in turn is affected by factors such as your current health, whether or not you are a smoker and your family's mortality history.
- Income and expenses. The income side includes resources besides what's in your savings accounts that you will have in retirement, such as an employer-sponsored pension and Social Security. It should also allow for whether your assets will be drawn down at all prior to retirement, and for whether or not you will work part-time. On the expense side, the focus should be on a detailed list of your spending needs in retirement, which may differ considerably from your current needs.
- Assets and debts. A key here is not just to account for the amount of your retirement assets, but also their tax status. That can have a major impact on the actual value you will realize from those assets when you go to use them.
- Rates. This includes the rates of return that will grow your stocks and bonds, as well as the future inflation and tax rates that will take their bites out of your savings.
- Household structure. This encompasses a variety of things that can affect your resources and your needs, such as your risk tolerance, gender and marital status, retirement goals and state of residence.
Is bad retirement advice better than none?
There is no question that all of the variables listed above can have an important impact on retirement planning. However, the sheer number of variables raises the question of whether it is possible to make an accurate projection of retirement needs and funding adequacy.
After all, doing so would require not just a retirement planning tool detailed enough to comprise all those variables, but it would also require remarkable insight in order to get the inputs for those variables right.
That complexity supports the paper's position that relying on a single answer from any financial planning tool is dangerous - usually, when you expect a simple answer to a complex problem, you will be disappointed.
Role of retirement planning tools
However flawed, retirement planning tools can at least provide some general direction as to your saving needs. The key is not to settle for a single answer, but to run multiple projections to get a sense of the range of outcomes. For example, see what it will do to your retirement saving needs if you live an extra five years, or if your assets under-perform your base case expectations, or if inflation runs a percent or so more than you originally assumed. To find out how much your retirement savings will be worth in the future against inflation, use a retirement savings calculator.
Along with running multiple scenarios, you should update your retirement planning projections regularly, to see how you should adjust your plans to new developments. What all of this will leave you with is nothing as simple as a single answer, but a range of possible answers. That will seem less definitive, but it is also less likely to lull you into a false sense of security.
Instead, seeing differing possible outcomes will give you a sense of how uncertain and sensitive retirement planning is, and that will help you be more cautious and flexible in your planning.
Comment: Do you use retirement planning tools? What works or doesn't work for you?
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