Pages Menu

Posted by on Jul 8, 2015 in ETF Strategist, Investment Perspective

The Futility of Retirement Calculators

The Futility of Retirement Calculators

By Roger Nusbaum, AdvisorShares ETF Strategist

USA Today syndicated a post from Motley Fool that did a good job taking down the concept of retirement calculators. The two big points made were that these calculators make an assumption based on people needing a percentage of their pre-retirement income, which does not take into account the particulars of individual circumstances, and that the calculators often overlook other sources of income including, in some cases Social Security.

As a result they tend to produce huge dollar amounts as being the retirement number. There can be a self-serving nature to the results produced, depending on whose calculator is being used. It is arguably in a giant financial services firm’s interests for someone to plug in their numbers, get told they need $2.3 million in 15 years, look at their $200,000-$300,000 and conclude “oh man I’m in trouble, I need to hire this firm.”

We’ve addressed the issue of ‘percentage of income’ many times before and the above linked article addresses some of them. Some people live below their means all of their lives. Of course someone in retirement is likely to stop saving for retirement which is one “expense” that goes away. Hopefully things can be timed in such a way that paying off the mortgage coincides with starting retirement which is another expense that goes away. Expenses related to health care and certain types of insurance are likely to go up. There are an infinite number of unique possibilities that could move expenses one way or another.

As a starting point is the quote I believe comes from Woody Allen that “there is no situation where having more money made it worse.” People need to save as much as they can toward a realistic number. The article takes a poke at the 4% rule but I believe it is the building block for understanding and if someone then chooses to do something different they are doing so understanding the basics.

The math isn’t complicated; the lifestyle expense minus Social Security equals the gap that needs to be covered by either portfolio withdrawals (or other investment income), some form of work or a downsizing of lifestyle. The amount of the annual gap divided by .04 is how big the portfolio needs to be for someone wanting it all to come from their portfolio and wanting to stick close to the 4% rule.

From there someone either gets to the number they targeted or they don’t. Not getting there is not the end of the world. Maybe $600,000 is the target but the result is only $450,000. This is not the difference between vacationing on the Riviera and eating at a soup kitchen. Something will have simply have to give which could be lifestyle or doing something to generate an income.

Another way this example can make up the difference is with proper asset allocation after retiring and getting decent up capture in the equity portion of the portfolio when the equity market is in the bull phase of its cycle. In an old post, John Hussman noted that since 1940 “bull market advances during this period have averaged a 123% price gain, a 162% total return, and a duration of 4.4 years. Bear market declines during this period have averaged a 35% price loss, a 32% loss including dividends.”

If someone is going to be retired for 20 or 30 years (or hopefully longer) they will obviously go through several of these three or four steps forward, one step back cycles and if the equity portion captures most of that, which is more about asset allocation and discipline than good stock picking, then there is a very good chance of getting the desired outcome, all the more so for an investor who can side step the full brunt of one or two of those large declines with a disciplined defensive strategy.

The AlphaBaskets blog provides frequent market insight and commentary by AdvisorShares Investments, LLC, created by AdvisorShares and other leading active managers.  AdvisorShares Investments is an SEC-registered investment adviser and the investment adviser to the AdvisorShares actively managed ETFs. The views expressed on AlphaBaskets should not be taken as investment advice or a recommendation for any of the actively managed ETFs advised by AdvisorShares.