How Accurate is Your Retirement Model?

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I recently had the opportunity to revisit retirement modeling software. As one of my jobs, I teach a economics course, and one of the things I tell my students and financial advising clients is that models can provide us with ideas of how things may work, but with all of the independent variables that exist in the world, they aren't likely to play out like we hope.

I was revisiting modeling software in part due to a recent critic of those that do not use "advanced" software to project hypothetical outcomes for clients. I used to. I've since given it up for many reasons. Mostly because I've seen life-changing decisions being made based on a model. "Mr. & Mrs. Client, you can take $50,000 out of your portfolio to buy that RV, and still feel secure in your retirement."

That was 2007's annual review of the model. After the market drop, the model was quite different, but the investor at least had a 2nd mobile home now.

Retirement models, like economic models or model trains, can show us a lot about the thing we're modeling, but it is no substitute for ongoing advice and planning. And, modeling a few worst cases along with the normal case is the least you should do when making decisions based on models.

Of utmost importance however is that you understand the assumptions and factors being used. I can not begin to describe the number of retirement models I've seen that were so flawed with incorrect data and bogged down by assumptions. There are often static assumptions (I save $6,000 to my IRA every year), and variable assumptions (rate of investment return).

In my opinion the mixing of so many assumptions in one software package most often leads to incorrect projections. For example, most individuals savings can be variable. You may make a Roth IRA deposit this year, you may not. But, how you project for it makes a difference in the outcome. Are you taking Roth IRA contributions from one account and putting it into another, depleting your savings in order to do so? Does your modeling software know the difference? If you know enough to tell it to.

Do you own a business? How is that being treated? Investments? What assumptions are being used for rates of return, interest, inflation…?

A recent tread is to model various social security strategies that couples may be able to benefit from. One variable that many who do this on their own may forget is the life expectancy. If you just ran the model without thinking beyond the various scenarios, would it give you the right answer, or is this just a case of garbage in, garbage out?

For that reason I strongly recommend a second opinion on any retirement strategy. Retirement models do not take into account the complexities that exist with the individual choices that feed into your personal financial plan. FPA's PlannerSearch tool can help you find local financial advisors to give feedback on your financial plans, and advice on the strengths, or weaknesses, of your retirement projections and plan.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright © 2010 FPA All Rights Reserved


This article appears in: Personal Finance , Retirement

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