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Keeping Both Eyes Open on the Path to Retirement Nirvana Back to Articles of Interest Author: Patrick Sarne On a recent trip to our Waltham office, I had a conversation with one of my colleagues. During the course of the conversation, he pointed to an object in his office and asked if I knew the significance of the Daruma. Although I had seen this traditional Japanese figure on many occasions, I hadn’t known the story behind it. The Daruma is a hollow, round doll modeled after the founder of Zen Buddhism. A symbol of perseverance and good luck, it is a popular gift of encouragement. It has also been commercialized by Buddhist temples as a sort of totem to support setting and achieving goals.
Looking to keep both eyes open along the path to financial security, investors and advisors turn to retirement calculators to help set goals. The simplicity of entering just a few assumptions about the future, and then receiving a numeric panacea to one’s financial concerns, broadens their appeal. The manufacturers of today’s calculators try to differentiate their products by providing additional calculations and fancy reports. But it’s the math behind these calculators that is the driving force, and the formulas rely entirely upon the assumptions that we supply. GARBAGE IN, GARBAGE OUT Inflation estimate. The historic average puts inflation around 3.5 percent. This is indeed correct over an extended time frame, but longer periods of higher (late 1970s) or lower (early 2000s) inflation have certainly occurred. And even just a small difference in the inflation assumption can result in significant increases to a client’s retirement savings need. Investment returns. Long-term historic averages for investment returns have certainly been calculated, but these estimates may mask periods of over- or underperformance. A difficult economic or market environment at the outset of one’s retirement is a real-world scenario experienced by many—especially today. What do we tell these retirees after years of plugging “average” historic returns into their calculators to arrive at an estimated figure for investment returns? Life expectancy. Actuarial tables provide guidelines based on date of birth, gender, and other factors. But highly variable factors like medical history can drastically affect this assumption. Simply put, no one can pinpoint an individual’s date of death. Clearly, determining precisely how much money a client will need to cover the costs of retirement is a daunting task—one made more difficult by reducing data input to a handful of seemingly simple assumptions. EYES ON THE PRIZE Retirement goals—when defined by retirement calculators—must be treated in a similar fashion. At least annually, it is crucial to revisit a client’s scenarios and to incorporate changes. Moreover, it is essential to examine multiple scenarios based on a variety of assumptions. Instead of entering our best guesses to calculate only one result, what if we entered the most conservative values into the calculator? Then, what if we ran a calculation with the most aggressive assumption? When completed, we would have bookends and could determine a range of possible outcomes within our high and low estimates. This would allow us to better prepare by making the appropriate adjustments. ASSUMPTIONS MAKE A DIFFERENCE
Now, let’s consider two different sets of assumptions to help us better define a range for our confidence interval.
As you can see, the differences in assumptions between Scenario A and Scenario B are not drastic. But when we enter the values for each scenario, the results are rather compelling. In Scenario A, our plan is right on track to reach our goal. In fact, at the end of an 80-year life expectancy, going down this path would provide the estate of our retirees a surplus of nearly $398,000, which could be left to heirs or charity. Following Scenario B, however, shows our couple running out of money before they reach the end of their lives. In fact, they would be broke by age 80, leaving a full 10 years of life left—and only one eye filled in on the Daruma. In order to achieve our goals in Scenario B, the Retirement Planner calculator encourages us to do one of the following:
Although any of these solutions would help our pre-retirees reach their goal, all are rather severe. Clearly, the above illustration shows how a few small differences in our assumptions can be exacerbated in the calculation over time. But, more important, calculating both scenarios has enabled us to establish a working reference range with clients, which we will revisit annually. No calculator can be clairvoyant, but we can maximize our chances of reaching retirement Nirvana by habitually reminding ourselves of our goal and regularly putting in the effort to achieve it. Understanding the limitation of the retirement calculator is the first step in properly making the most of it. Despite its shortcomings, it is still a fantastic tool to help plan and test different retirement outlooks. Source: Tresidder, Todd, “Can You Trust Retirement Calculators?” financialmentor.com, August 2011 Patrick Sarne is an investment consultant in the Investment Consulting Services group. He is available at psarne@commonwealth.com. |
 
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When new, the Daruma’s eyes are blank; the owner fills in one eye upon setting a goal and the other eye later, when the goal has been achieved. One tradition explains that, in order to motivate Daruma-san to grant your wish, you must promise to give him full sight once the goal has been accomplished. This belief has led to a common phrase, which, translated from the Japanese, means “keeping both eyes open.”
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