Understanding Retirement Calculators

Determining how much you can withdraw in retirement can be fairly complex. Typically, we recommend limiting annual withdrawals to around 4% of your total portfolio value at the time your withdrawals begin. But if your retirement distributions are years away, estimating this starting value is no easy task. A retirement calculator can’t do this perfectly.

Calculators require numerous inputs, many of which you can’t estimate with certainty today. If you’re still working, you’ll need to consider factors like how much you expect your pre-retirement investments to return, how long until you retire and how much you’ll add to your savings before retiring. You’ll also need to estimate when you expect to start taking regular cash flows, your portfolio’s balance, how long you expect to need retirement income and what growth rate you expect your savings to earn in that period.

The problem is, retirement calculators don’t tell you how to invest. Asset allocation—the mix of stocks, bonds and other securities you own—is the biggest determinant of your long-term returns and how much you can withdraw over time. Calculators don’t tell you this. They don’t tell you the straight-line return you assume you’ll earn during retirement might not be realistic given your current investments. Calculators won’t tell you if you need significant equity exposure over time in order to reduce the risk of running out of money.

Instead, calculators ask for hypothetical growth rates—pre- and post-retirement. While it’s good to have an idea what kind of growth you’d like to achieve, it’s unrealistic and unwise to stake your financial future on hopes. Hope isn’t reality. Even estimates seemingly based on reality might not do much good. Stocks have averaged around 10% annually since 1926.* But to achieve those averages, they’ve had to swing (wildly) between extremes—market returns vary, even if they’re up more often than not, and how the timing of both portfolio contributions and withdrawals stacks up against the markets’ ups and downs can have a large bearing on how much cash flows your portfolio can sustain.

Asking for two different growth rates introduces another fallacy—the notion your investments should look vastly different pre- and post-retirement. Do your long-term goals change the day you retire? Does the target suddenly change once you’re no longer earning a paycheck. For most folks, the answer is, “no.” Most folks have goals they want to achieve over their entire investment time horizon, and we think those goals should be the bedrock of their investment strategy, period—not arbitrary rules of thumb and industry mythology. If you know today where you want your money to be in 10, 20, 30 or more years (however long you need to be invested for your money to provide for you and your family) you can develop a plan now. If it’s done right, it needn’t change radically when you retire, though some alterations to reduce expected short-term volatility once you begin taking income might make sense.

By distinguishing between the number of years before and after retirement, these retirement planning tools also create the false sense your retirement date is an end-date for the “growth” portion of your investing years. It isn’t. Most folks’ time horizons don’t end at retirement. Time horizon is the total length of time your assets need to work for you. Most folks need their savings to grow throughout their whole lifetime—which is often longer than most expect thanks to advances in modern medicine. Some folks need their savings to last beyond their lifetime, if they need to provide for a spouse or heirs.

Finally, how much you’re currently putting away for retirement is good to recognize, but don’t get over confident with your savings rate. Even with the best intentions, some savers don’t end up being as disciplined as they had hoped over the years. How much you plan to save isn’t always what you actually save. Planning otherwise can mean setting yourself up for disappointment.

Ultimately, you can’t take a retirement calculator’s results at face value. Using a tool like this can help you get an idea where you are and what sort of lifestyle adjustments you might need to make in retirement. But true, actionable retirement planning requires great introspection to understand your investing time horizon, goals and objectives. An investment adviser, like Fisher Investments, can help, too. When we help clients plan for retirement, we ask the tough questions for them and use our tenured investing expertise to develop an optimal portfolio plan designed specifically for you.

*Source: Global Financial Data, Inc., as of 02/25/2014. The S&P 500 Total Return Index averaged 10.0% annualized returns from January 1926 to December 2013.