Wednesday, June 9, 2010

Retirement Calculators

It has been a long time. I have been busy with teaching and other official business of the university. However an article in on retirement compels me to write in this blog.

It says, "Every major financial services company has an online tool to estimate how much money you need to save for retirement. But a recent study by the Society of Actuaries says many popular calculators have serious flaws. These potential hazards could lead to serious miscalculations when you’re plotting your financial future."

The first problem is in assuming the rate of return of your savings. Most calculators use fixed rates of return. In order to be realistic, calculations should allow users to assume different rates of return on investment and even use probabilistic rates with reasonable standard deviations.

The next issue is how to handle life expectancy. Most calculators use the life expectancy figures. This figure is only useful if you die at the age according to the average person assumed in the calculation. If you live slightly longer, you will end up with very little money when you need it most.

The next problem is how to handle inflation. Inflation rate assumption plays a very important role in determining whether you will be able to live your retirement years according to your plan. It is necessary to allow users to look at different scenarios using different inflation rates.

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