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Online calculator article from CBS MarketWatch
Retirement calculators off target
Software oversimplifies assumptions, skews long-term goals
By Jackie Cohen, CBS MarketWatch.com
SAN FRANCISCO (CBS.MW) -- When planning for retirement, don't take the advice of an online calculator without a lump of salt.
Among other oversimplifications, most of these free applications assume static rates of inflation and investment returns when in reality these factors fluctuate widely.
"A much more accurate approach looks at the likelihood that you will reach a particular investment goal if you do certain things," said Brian Orol of the Strategic Financial Planning Group, Raleigh, N.C. "But showing that to people scares the heck out of them."
Talk about scary: The average American only has a 20 percent success rate in striving to meet retirement goals, at least in the eyes of Gregory Kasten, a financial planner at Unified Trust Co., Lexington, Ky.
To raise that to a 70 percent success rate, most people simply need to increase their savings, rather than focusing on aspects of the economy they can't control, Kasten noted.
But that's precisely where the calculators go wrong. They indulge people's idealism, letting them choose annual rates of inflation and investment returns.
Alas, the markets' performance over the past 10 years has dashed even the most conservative theories about average annual returns on investments.
Here's a dose of realism. "Within any given 12-month period, you have a one-in-three chance of having a negative return on investment," said Kevin Taylor, a financial planner with H & R Block in Overland Park, Kan.
Indeed, the notion of an average annual return works best with long investment horizons. Crimp that and things become more of a crapshoot, especially if the performance gets off to a weak start.
"People mistakenly focus on investing for a rate of return rather than an asset goal," said Grady Layfield, a financial planner at Stanford Financial Group in Baton Rouge, La. "Having an asset goal [the final lump sum you want in your nest egg] should determine your savings allocation each year."
In a similar vein, real inflation rates may vary more widely than even the federal announcements lead us to believe.
"The consumer price index doesn't include everything that affects inflation," said planner Orol. "More than one-third of its data is based on certain assumptions made by the economists who compile the index."
More importantly, inflation rates actually spike during retirement because health care becomes the biggest expenditure during that phase of life.
"Health-care inflation has been double digits for the past five years, at least," said Orol. "It's your largest variable expense, but you don't know when it's coming, in what form and how much it will be."
Another major shortcoming: capital gains taxes don't figure into the calculations. If that were the case in real life, more people would have enough money for retirement.
Instead, "what you need to know is the real rate of return, which adjusts for inflation and taxes," said Kasten. "It's very unusual to have a real rate of return that's higher than five percent annually."
Complicating this further is the fact that "tax brackets inflate every year, but most people assume an average tax rate. And that makes a huge difference," said Mark Ferris, an independent financial planner in Old Saybrook, Conn.
One other factor can make a huge difference: The potential diminishing of Social Security benefits. So, rather than presume the money will be there, it makes sense to assume the opposite, financial planners say. Better to be pleasantly surprised than disappointed.
Certainly, including all of these factors in a retirement calculator would quickly fatten up the software to the point that it could bog down a Web site, hence the prevalence of stripped-down applications.
A more-thorough analysis of one's finances can best be achieved in a meeting with an investment adviser. But that doesn't necessarily require a commitment to a full-service brokerage.
For some full-fledged advice, consider scheduling a one-time appointment with a financial planner to draw up a retirement-savings plan. To avoid conflicts of interest, go to someone who charges an hourly rate.
Those calculations are more likely to help you meet your retirement goals.
Jackie Cohen is a reporter for CBS MarketWatch in San Francisco.
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