Calculator: Jumpstart Retirement Planning

A Simplified Version

The retirement planning calculator is a simplified version of the original model, and should only be regarded as one arrow in the retirement planning quiver. We say it is “simplified” because it only considers a single future time period or investment horizon – from date of retirement to life expectancy. This one period analysis does not provide for the added complexity of different scenarios or complicated retirement transitions (i.e. an individual decides to work part time in the first five years of retirement; an individual who defers Social Security benefits for a certain time period). Life expectancy depends on age, health, etc. Based on actuarial tables, females and males that reach age 65 live to age 85.5 and 82.9 respectively. However, people in good health can live well into their 90s. So, for a 50- or 60-year-old individual, the investment time horizon in retirement can be 30 to 40 years. This period is often longer than the number of working years during which an individual saved for retirement. On the other spectrum: an individual unexpectedly inherits money or sells assets like real estate that substantially increases the size of the retirement portfolio, producing more retirement income than needed. This calculator offers the addition of such entries with only crude outputs; no calculator can possibly address the myriad financial scenarios investors will face.

Despite its limitations, we believe this retirement planning calculator is far more comprehensive than many others available on the market. The simple plug-and-play design of some retirement planning tools does not adjust for inflation and fails to include different assets as well as liabilities. This calculator allows individuals to input basic data, like how much they have in today’s dollars, expected needs for retirement income (also in today’s dollars), current savings and how much should be saved each year prior to retirement. Other inputs: future savings goals (including corporate retirement plans, IRAs, personal accounts and so forth), investments viewed under different legal structures, and assets subject to long-term capital gains or ordinary income taxes. One side note: A more complex retirement plan should analyze before and after-tax returns across different investment accounts. The investor might want to place more highly taxed assets in accounts that are either not taxed or taxed in the future when an individual’s tax rate might be lower. If properly analyzed, the combination of these factors will help determine the allocation of an individual’s retirement investment portfolio among low- and high-risk investments.

Goals-Based Investing for Retirement

When investing, people often make two mistakes; first they do not formulate a good investment plan and secondly, they do not stick to the plan. One reason people often do not stick to their plan is market volatility. If they are not emotionally prepared to ride out market down-turns, they often withdraw at the bottom of a cycle and then miss the longer terms returns their investment plan set out to achieve. That is why the premise of “goals-based investing” (first proposed by MIT Professor Robert C. Merton) holds sway in the retirement discourse. It is not an investment plan that strives to duplicate market results or build comparisons to benchmarks. Instead, it is an investment plan that attempts to identify realistic levels of returns that will help an investor meet his/her financial needs, typically beginning with the most fundamental goal of generating adequate income in retirement. Goal-based methods incorporate recourse decision-making and adaptive trade-offs (goal reprioritization, risk preference, time horizon, expected return) into the asset allocation process. Success is measured by how well an investor’s portfolio is tracking against the stated goal.

Simply stated: goals-based investors do not fixate on short-term returns, volatility or the current value of retirement assets, but rather focus on the end goal (expected retirement income) and whether the investments are on track to meet those needs in the future. In doing so, these investors may have a better decision-making framework that may lead to more rational investing and better outcomes.

The Polaris Retirement Calculator is aligned with this approach. An investor can define the “target annual income in retirement” and then input asset values and the risk/return category of each calculator “bucket” to see where they stand in meeting their income goals. The user can change the asset allocation, risk tolerance, return projections, consumption needs, etc. in the calculator to model different strategies and timelines to reach the desired retirement income. The calculator can also serve as a counterbalance to market volatility irrationality. If concerned about short term volatility, simply update the calculator to see what effect a short-term downturn truly has on long-term retirement goals. And if the portfolio will be impacted, the calculator framework allows the investor to modify risk behavior to achieve income goals over a lifetime.

The Importance of Real Returns

One of the primary reasons retirement analyses go wrong is that the projected returns from a portfolio are not in real, inflation-adjusted terms. Real returns must be used to avoid the inaccuracies of trying to predict inflation over many decades. This is why one should use an individual’s current income to judge how much will be needed to live on in retirement. Accurate retirement plans should use today’s real income and expected future portfolio returns in real terms. The other and incorrect approach uses higher nominal returns (including inflation) to project portfolio values. These nominal returns overinflate future portfolio values that then overestimate the amount of income, in today’s terms, that will be available for retirement.

For instance, many recommendations assume bond returns of 3-5% or more, which is what some bonds may yield today. But when we observe what investments have earned after inflation or in real terms over the last 75 to 100 years we see the following:
Treasury Bills: 0.5%
10 Year Government Bonds: 0.75% to 1.0%
30 Year Government Bonds: 2.0%
Equities: 7.0%

Because there is no certainty as to what inflation will be in the future, a good rule of thumb is to consider using a “real rate of return” assumption – translating future retirement numbers into today’s dollars. The Polaris Retirement Calculator does just that.

Why Use This Calculator?

We’ve found time and time again in working with clients over the last 40 plus years, that most individuals have a very difficult time looking at their current investments or retirement nest egg and determining whether it will be enough for retirement. And if not, how much does an investor need to save to reach that goal? This retirement planning calculator allows individuals to input their current financial situation, estimated future savings until retirement, and project out through retirement to see whether those savings will provide enough income to ensure a comfortable lifestyle. Armed with those numbers, an individual may: 1) reevaluate and trim expected future expenses, 2) save more, 3) explore more aggressive investment plans if underfunded, 4) reduce the riskiness of the portfolio if well-positioned financially or 5) use excess assets (more than is needed for retirement) to invest on behalf of heirs. Each scenario may be prescient to a different audience. We welcome you to use the Polaris Retirement Calculator to get an initial view to your retirement picture and ultimate goals!