Are you curious if you are saving enough for retirement? Are you putting enough money away in your IRA? Are your payroll deductions enough to fund your retirement from your 401(k)? These are questions that many people ask themselves all the time. And rightfully so as these are some extremely important issues for most people. And most of us rely on the use of online investment calculators or spreadsheets that are set up to show your investment potential. But how good are these tools to project your investments?
Well, the answer to that is both simple and complex at the same time. As for the simple approach, they are as good as the person who set them up and the assumptions that you input into them. Most are set up fairly well and are accurate, or as accurate as the data you use for your inputs. So where do you get the data to input? Well, that depends on you and what assumptions you want to make. You can always search the Internet for historical returns on different asset classes. For example, you want the returns for the S&P 500 you just need to do a search for them for a particular period. You want to use a sample that is indicative of the returns you wish. Here the general rule is to use a sample that covers most periods of the ups and downs of the markets. Many use the annualized return of about 9% for the broad markets. And that figure should be acceptable provided you are invested for the long haul.
So you will need to perform that exercise for each asset class you have your investments in. And it is wise to use asset allocations to diversify your portfolio not only to reduce risks but in most instances increase your overall returns. I know that sounds strange but it is true and something I will cover at a later date. But any time you can lower your risks and not at the expense of your returns who would not want that?
So you have selected a tool to calculate your investment’s future potential, and now you have your historic returns. Now please remember that past performance is in no way and indication of what the future returns could be. But that is why I hope you either selected a period that represents both the ups and downs of the markets or were more conservative in your estimates. Better to error on the side of being conservative instead of more aggressive.
Now that is the simple approach and the most practical as well as you will soon see. So what is wrong with this other than you need to have faith in the calculator as well as the returns you use for your input data? Well, the markets do not produce level or consistent returns of say 9% every year. That means that in some years or periods of time your portfolio will over or under achieve your 9%. Think of the last seven years and the bull market we have been in and then think of the Lost Decade of the 2000’s where stocks basically had no return on an annualized basis. This means if you use 9% for your return the program will assume that this is the return each and every year. And as we just discussed the markets do not work this way at all.
Think back to the Great Recession where portfolios lost up to 60% of their value. Then three years later they had recovered for the most part. But the calculators do not take these wild swings into account. So you need to be aware of this when you use a calculator that simply utilizes an annualized return. But as I stated, over a long period this should not matter as much as the return will approach the annualized percentage. But when you have events such as the Lost Decade or the Great Recession it will indeed make a difference to your portfolio’s value.
So what can you do? Well, not much really other than use a more conservative value for your returns and be aware that these returns are annualized, and the markets do not always return that amount. And by being aware of this, you can make certain assumptions to help give you a more accurate picture. It is also important that you understand that past performance does not mean the future will act in a similar fashion. I am not aware of an online calculator or one that is reasonably priced for the masses that will take market swings into account. But as long as you are aware of these issues you can adjust your inputs as needed.
So yes these can be useful and are in some ways even necessary for you to estimate your returns and projected value of your portfolio. But do be aware of their limitations and faults. I am an affiliate of Simple Planning which makes a suite of Excel spreadsheets that do these calculations for 401(k)’s and investments in general. If you are interested in the entire package at a very reasonable price, please visit http://bit.ly/2q7dbjS and for just under $40 you will get eight very useful spreadsheets. They also sell them individually so if you do not want the entire eight you can get just what you need. But the price for the eight is a real value, so I would seriously consider that option.
If you have any questions or need any additional information, please feel free to contact me or leave a comment here.
