Are you on-track for retirement? Most retirement planning websites ask this question, or something very close. There are numerous retirement calculators that claim to be able to answer it. If you’ve tried a few, you’ll no doubt realise that the answers they give differ widely.
Can retirement planning be reduced to such a simple yes-no question? And if not, what question should we be asking?
On-track: yes or no
Let’s say a retirement calculator asks you a few questions and then simply answers ‘yes’ to the ‘on-track’ question. How useful is that? Well, you might feel reassured that you’re not over-spending or under-saving. But you’d have no idea whether or not you could afford to spend a bit more.
On the other hand, suppose the answer came back as ‘no’. That doesn’t tell you by how much you need to cut back your spending.
Clearly yes-no is the wrong type of question.
You money will run out in X years
Say the calculator told you that your money would run out after 30 years. At least now you can try adjusting your spending until your money doesn’t run out. But what if you live longer than 30 years? The calculator might suggest that you assume a life expectancy much longer than the average, just to be safe. If you do that, then you’ll need to reduce your spending until the calculator tells you you’re on-track.
There are two big problems with calculators like these:
- They assume that investment rates of return are fixed. As we’ve seen during the coronavirus pandemic, that’s a dangerous assumption.
- No account is taken of the variability of life expectancy.
So this type of calculator tries to answer the question ‘How long will my money last?’. We’ve now moved away from a yes-no question. But this is still the wrong question.
You have an X% chance of running out of money
If your calculator can tell you something like this, then it’s an improvement. It means it’s running a Monte Carlo simulation. This involves running a large number of random scenarios. Each scenario randomises certain variables such as investment returns and the rate of inflation.
So now we’re asking the question ‘What’s the chance of my money lasting for X years?’.
The best such calculators also randomise life expectancy, so you don’t have to guess an arbitrary number. The question then becomes ‘What’s the chance of my money lasting my lifetime?’.
You might suppose that this is equivalent to asking ‘What’s the chance that I’m on-track for retirement?’. But there’s a subtle difference. For most of us, being on-track for retirement means more than simply not running out of money. We might want to leave a legacy. Or we might want to minimise the stress of high-risk investing.
The question’s getting much better. But we need to improve it even further.
Your best strategy for getting on-track
The right question we should be asking is ‘What is my best retirement strategy consistent with my goals and risk tolerance?’. In other words ‘Please show me how to get on-track.”.
Using your calculator, you shouldn’t need to try out every combination of strategy settings. The calculator should be able to take your inputs and adjust your strategy settings to a combination that gives the best results. But it should also use Monte Carlo simulation to take into account uncertainty.
Ours is the first and only online calculator that does all of this. It optimises your strategy to get the results that best achieve your goals and attitudes. To do this is uses a powerful technique known as a Genetic Algorithm. The EvolveMyRetirement® calculator also makes extensive use of Monte Carlo Simulation. The combination of these two techniques for retirement planning takes place behind the scenes. Our calculator answers the right question.