At its heart, the idea of planning for retirement is very straightforward. Like squirrels in the autumn, hopeful future retirees stash away some of the nuts they gather Age calculator each day so they’ll be able to eat when the gathering season is past. Unfortunately, the problem is more complicated for us humans. Squirrels only need their stash to last for a few cold months of winter, while retirees depend on their stash for thirty, forty, or even fifty years. This difference can make the problem seem overwhelming, and can leave people frozen with indecision.
To make matters worse, we’re inundated with conflicting advice about how we should invest our savings to best accomplish our retirement goals. Should we hire an investment advisor? Should we use index funds or actively managed funds? What funds should we buy? How do we build the very best portfolio to get the highest returns?
While these questions are valid, they become inconsequential if the apprehension they produce causes us to do nothing. What matters most is whether we save enough money for a long enough period of time and whether we make reasonably good investment choices. Notice I said reasonably good investment choices. Too many people feel that successful financial planning is about scoring frequent Jim Cramer style “booya” home-runs on brilliant stock picks. The facts just don’t support this oft repeated lore. What really matters is that you develop a solid plan and stick with it.
When can I get off the treadmill?
To determine how much you need to retire, you must first decide how much you want to spend in retirement. What standard of living do you desire in retirement and how much will it cost to fund that lifestyle? This is by far the most important question in retirement planning.
Fundamentally, this is a question about trade-offs. How much should we sacrifice during our working years, and for how long, so we can be happy during those golden retirement years. The tradeoffs get even more complicated when you consider other competing factors such as children’s education, the care of elderly parents, and concerns about one’s own health. Once again, it’s easy to get bogged down in the complexity of it all, but like any decision involving trade-offs, it becomes much simpler if we can understand what the costs and benefits of our various options are.
This is where a retirement planning tool can help. A retirement calculator can help you experiment with different levels of savings, different retirement ages, and different levels of retirement spending. By using a retirement calculator to run retirement “experiments”, you’ll be able to see the costs and benefits of choosing among the various paths. Retirement planning is deeply personal, and only you can decide what trade-offs make sense for you and your family.
I’m ready to calculate. Now what?
Retirement calculators can provide you with information to help you make choices about various retirement options. But remember, these tools are not “smart” and they can’t weigh the options for you. Their role is to assist you by arming you with the information you need to make good choices.
Most retirement planning tools ask you to provide information about expected savings, desired retirement age, and the annual expenses you plan to incur during retirement. The tools use this information, along with assumptions about inflation, taxes, and portfolio performance, to estimate the likelihood that you’ll be able to fund your expenses for the duration of your retirement.
This likelihood of success is the tool’s way of indicating how solid of a plan you’ve constructed. If the likelihood (or probability) of success is low, say below 50%, then you have a less than 50/50 chance of having enough money in retirement. On the other hand, if the probability of success is above 90%, then your plan has a very high likelihood of being able to provide income you’re seeking during retirement.
Wait a minute you say, I simply want to know if my plan works. Why can’t the tool just tell me that?
Most advanced retirement planning tools use the concept of probability to report their results. This is because most tools work by running thousands “simulations” of your retirement. In each of these simulation runs, the software plugs through all of the calculations of your retirement year-by-year to see what happens. In the runs where the simulation reaches the end of the plan and still has money to spare, the run is called a success. Runs where the money is gone before the end of the plan are called failures. The ratio of successes over failures is your plan’s overall probability of success.
Still you say, why does the planner need to make thousands of simulation runs? Why doesn’t it just do it right the first time and give me the right answer? Well, it turns out that long-range planning, such as retirement planning is not an exact science. No one knows for sure how investments are likely to perform in the future, so the best anyone can do is try to make estimates of the future. The problem with making an estimate is that it could be wrong. So instead of making just one estimate, several thousand estimates are made. Most planners do this by considering how investments have performed in the past and then using this information to make guesses at what might happen in the future as your retirement plan unfolds. They do this over and over again and record the results of each “run”. Then they summarize the results by showing the overall probability of success for the plan.