Pitfalls in Retirement Calculators

One of the first steps for anyone trying to plan for retirement is to use a retirement calculator. Often one of the many free calculators available on the web is used, though there are several available that charge modest fees. Of course, some people have a financial planner prepare the calculations using a software calculator that might be more robust than the free tools available on the web. I’ve discussed the web calculators at different times in the past, in both my books and in  Retirement Watch.

Here’s a warning that bears repeating. Most retirement calculators especially the web-based ones, use historic investment returns to determine the redults of your plan. Those long-term returns were too high for most people who invested over the last 10 years and likely are too high for someone investing over the next 10 to 20 years. Don’t simply look at the final numbers in a retirement plan. Look at the numbers that lead to the final number. Does the calculator assume 8% or higher annual returns from stocks? 5% or greater annual returns from bonds? If so, you might want to be skeptical about the results.

Today many advisers are looking out a decade or so and lowering the rate of return they expect from stocks and bonds. Jon West, a director at Research Affiliates, which manages $50 billion, says the firm’s number crunching leads it to estimate that stocks could deliver 5 percent to 6 percent, and bonds 2 percent or so. That’s based on getting “at least 2 percent less from dividends,” anemic earnings growth, and no growth in the stock market’s price-earnings ratio, he says. It produces a return below 5 percent for a 60/40 portfolio. That’s a far cry from 8 percent.

Vanguard founder Jack Bogle has a slightly more upbeat assessment. He expects stock returns of 7 percent to 7.5 percent over the next decade. He assumes no expansion in the market’s price-earnings ratio, dividend yields of 2.2 percent, and earnings growth of at least 5 percent. Bogle expects bond returns to be about 3 percent. For a balanced portfolio, that produces a net nominal return of slightly more than 6 percent. A higher forecast is T. Rowe Price’s estimate of 7 percent; until this year it had used 8 percent.