There are dozens of retirement calculators available online for the casual user. Some of them are published or sponsored by companies that want to sell you stocks or stock mutual funds. Because of this, retirement calculators may give you feedback that is overly optimistic. This false optimism arises because the calculator plugs in expected market return data that probably is no longer valid.
The problem is that bond yields are far below historical numbers. So are dividend yields, which in the past have contributed as much as 50% of the annualized gains achieved by stocks. Accordingly, many experts say that expectations for future market returns should be downgraded to 5% annually or less. If you believe as I do that a retirement investor needs to be more conservative and realistic, the important question becomes:
Is your retirement calculator or adviser using unrealistically high market returns when analyzing YOUR situation?
Bloomberg recently published an article on this very topic and, among other warnings, had this to say:
More sober return realities aren’t reflected in all of the online retirement calculators. Some, such as ones offered by Principal Group and Yahoo! Finance, use 8 percent as the default rate. Others, including the AARP and Bloomberg calculators, default to 6 percent. The Labor Dept.’s calculator plugs in 5 percent. Vanguard’s gives savers a slider to play with that’s initially set at 5 percent. It labels 5 percent “conservative” and describes a return anywhere from 6 percent to 9 percent as “moderate.” That’s a mighty wide range.
A calculator that uses Monte Carlo analysis can help eliminate a bias toward unrealistic past returns. The calculator that I use most (Financial Engines) employs a Monte Carlo system. However, even this system has its faults, as the Bloomberg article points out. For that reason, I like to cross-check my expectations using other calculators that let you plug in your own, more conservative expected returns and compare.
I believe the best advice here is that when you are using a retirement calculator yourself or relying on advice from an adviser, make sure you know what is being assumed to be the expected market returns for your portfolio. If you see or hear something in the range of 8%, ask to see the results for 5% or less.
Here is a link to the Bloomberg article: That Retirement Calculator May Be Lying to You.