I have bad news. You could miss your target by a mile, even if you invest exactly as the retirement planner says.
I also have good news. A new calculator on the Web offers better estimates than you’ve probably had before. There are no guarantees. But you should at least test this service–called Financial Engines (www.financialengines.com)–against any savings target you’re using now. You might find that you’re running a greater risk with your future than you thought.
Click, poof: In concept, retirement calculators are pretty simple. You (or your planner) enter your age, salary, pension, if you’ll have one, and current investments; also, the percentage of salary you’re saving, a retirement age and the future income you’d like to have. You’re usually supplied with a Social Security estimate. You click a button and poof, the calculators tell you (1) yes, your plan will work or (2) no, you’ll fall short. They reach that conclusion by forecasting what your current investments are likely to earn.
If you’ll fall short, you make changes in the plan–say, a later retirement age or a lower income goal. You might also decide to put more money into stocks. Eventually, you’ll find a mix that the calculator says will work. It’s an estimate, of course. Different calculators say different things. But you think they’ll all come close.
Think again. Most calculators, including those used by professional planners, take too narrow a view of the world. When you ask them how much you ought to save to reach your retirement goal, they give you one answer: “$xxx a month.” Or maybe a “best case” and “worst case,” so you can pick something in between.
But in real life, there are millions of possibilities. The growth of your nest egg depends on which investments you choose and the actual price you pay, each time you buy. Some investors will earn much more than the calculator forecasts. Others will have to settle for less. What are your chances of landing in the richer group?
Most people think that the best way to improve their odds is to put more money into stocks. Indeed, that’s what the typical calculator shows. But markets sometimes go down or go nowhere for long periods of time (yes, kiddies, it’s really true). Stocks raise your odds of doing well but they also raise your odds of missing your retirement goal–maybe by a mile. That’s what most calculators don’t show. You cannot tell how much risk you’ve taken on.
Enter Financial Engines (FE). It’s the brainchild of Nobel economist William Sharpe and–uniquely among Web calculators–gives you a feel for your investments’ chance of success.
For example, say you have a retirement plan that a standard calculator (or your financial planner) says is going to work. When you enter it into Financial Engines, you might see that its chance of working is, say, 50 percent. Half the time, your mix of investments will succeed; half the time it won’t. Do you want to take that risk? Or would you rather aim for a little more certainty? Financial planner Lynn Hopewell, of The Monitor Group in Fairfax, Va., says that his clients typically want plans with an 80 or 90 percent chance of success. “Financial Engines is heading in the right direction,” he says. “People had better pay attention. It’s the coming thing.”
Tote board: The math behind FE’s calculator is literally too sophisticated for words. In concept, it tests millions of possible economic and investment outcomes to judge how solidly you’ve built your retirement plan. Think of it as a racetrack tote board and you’re the horse. On the board (the Web site), you’ll see the odds that you’re going to win. If the odds are poor, you can recast your plan and try again. All this for free.
FE also sells investment advice to people with tax-deferred retirement plans. You pick the level of risk you want (a 50 percent chance of reaching your retirement goal? An 80 percent chance?). Within that limit, FE suggests which of your plan’s specific mutual funds to buy, and what percentage of your money to allocate to each. If your plan includes some mediocre funds, FE will steer you away. “Are we going to make some people mad? Yes,” says Sharpe, happily. Cost of the service: $14.95 every three months. The recommendations take into account your company stock and securities held outside your plan. FE has already signed up some major 401(k) plans to help participants choose better funds.
The next question is, will investors understand FE’s message? Francois Gadenne, cofounder of Rational Investors (RI) in Peabody, Mass., supports the tote-board concept but thinks it’s over the public’s head. RI sells Web retirement calculators to the providers of 401(k)s and lets the plans build in a single, projected level of success. For example, all calculations might reflect an 85 percent chance (by RI’s math) that employees will reach their retirement goal. Employees see only the dollars, not the odds.
What if you’re using an old-style Web calculator–one that simply says, “save $xxx a month”? What are the odds that that advice is right? Even their creators don’t know. Richard Stevens of Vanguard, which has a popular free site (www.vanguard.com), can say only that its assumptions are conservative. And indeed, one Vanguard plan that I put through Financial Engines showed a high likelihood of success. Stevens says Vanguard has a higher priority than tote boards–namely, developing calculators that adjust for taxes, when suggesting investment changes in taxable accounts.
Whatever their goal, none of these calculators should be mistaken for God. Two similar planners will give different results, because they’ve made different assumptions about your future income or Social Security benefits. But Web forecasts will get better, fast. They’re going to become the People’s Plans.
