Posted on January 6, 2019

The most common question one encounters when considering the prospect of retirement is how much money will be needed. Doing a simple internet search will result in a variety of retirement calculators where, using some simple assumptions, one can calculate the money needed for retirement. However, most of these calculators are wrong. Here is why.

The two main types of retirement calculators are either based on how much one earns or how much one spends, with the most common type the former. However, how much one earns today has little value in determining how much one needs to retire. Therefore a more accurate retirement calculator will be based on spending only.

The main idea behind the salary based retirement calculators is lifestyle. That is, if one enjoys a rather lavish lifestyle now then he/she will most likely expect the same lifestyle in retirement. That is a reasonable assumption but problematic. I'm not sure about you but I have no expectation to have a large house, take many vacations and eat our constantly in my 80s. In fact I expect expenses overall to be much lower, except for healthcare, when I get older due to physical and mental constraints.

A better way is to estimate retirement needs is based on the expected portfolio value at retirement and the expected annual expenses in retirement. A great website I found is firecalc. Using a few basic estimates such as portfolio value and expected annual spending, firecalc runs through over 100 different historical scenarios since 1871. Firecalc then tells you how many scenarios past (i.e. lasted through retirement) and how many failed.

To give an example, Schwab told me I needed $1.5 million to retire at age 67 (ugh!) whereas firecalc told me a retirement portfolio of $1 million spending $40,000 annually had a 97% chance of lasting 30 years (social security was used in both estimates).

One has to take in consideration the source of the retirement calculator. For instances, most brokerage firms offer their own retirement calculators to the general public. These firms have a monetary incentive to skew figures higher as they make money off of retirement portfolios. I have found retirement calculators to be exceptionally high from brokerages which is not only inaccurate but also discouraging for the saver.

Focus on spending-based retirement calculators for determining how much you need to retire. Earnings-based retirement calculators may not give an accurate picture on how much you really need and how soon you can plan on entering retirement. Spending also allows much more flexibility since spending can be managed for the most part and retirement planning could be accelerated if desired.