Below are some of the most common questions about the Charting Your Retirement Calculator and some of the content on this site.
Q. What do “Today’s Dollars” mean?
“Today’s Dollars” takes into account inflation when looking at future years. 2.5% is a common inflation rate and inflation has been averaging around 2% over the past 8 years. Using a 2.5% inflation rate example, $100 today would be worth $102.5 in one year, $105.60 in two years, but in “Today’s Dollars”, they are worth $100. It is usually best to use “Today’s Dollars” to normalize future dollar amounts. Another example, your $500,000 house might sell for $640,042 in 10 years (assuming it appreciates at the same rate as inflation), but in “Today’s Dollars”, it is still worth $500,000.
Q. How often should I update the retirement calculator?
Once you enter your data the first time, your data will be preserved for future changes and any tweaks you wish to make. At a minimum, you should update the calculator at least once per year. But, to get the most benefit out of the calculator, you should plan to update it whenever there is a material change in your income or assets. Also, one of the biggest benefits to the retirement calculator is the ability to make what-if changes. For example, changing your investment return, beginning social security benefits earlier or later, choosing to downsize your house earlier.
Q. What is the difference between “Taxable Portfolio”, “Tax Deferred Portfolio”, and “TaxFree Portfolio”?
A “Taxable Portfolio” would be an individual or joint investment account. It might hold stocks, bonds, ETFs, mutual funds, commodities, collectibles, and even cash. Every year you would pay taxes on interest, dividends, and capital gains. A “Tax Deferred Portfolio” would include 401Ks, 403bs, and traditional IRAs. You would only pay taxes when you start to withdraw funds. Finally, a “Tax Free Portfolio” could be a Roth IRA or other asset where no taxes are due.
Q. What is a Monte Carlo Analysis and why is it important?
Monte Carlo simulations provide a more probabilistic profile of how future years may evolve by randomizing investment returns based on the past 67 years. Typically, most retirement calculators require a single value for investment return and a user might enter a value between 2 and 10%. However, history reveals that investment returns can swing wildly from year-to-year. In fact, you could have multiple consecutive down years that might deplete your assets and you may not recover from them. As an example, the 1973-1974 bear market saw a decline of close to 40% and the dot-com crisis saw a 40% decline between 2000-2002. The Charting Your Retirement Calculator uses 1,000 simulations using a mix of stocks and 10-year treasury bonds for generating probabilities. The Monte Carlo simulation is an optional feature and provides an additional data point in addition to using a fixed investment return.
This chart shows a low probability Monte Carlo simulation. This couple only has a 40% chance of outliving their savings. Starting in the year 2030 their probability starts to decline and declines at a more rapid pace in later years.
Monte Carlo is one of many modeling tools that could be used, and one must remember that it simulates the future using historical data and it does not predict the future. Actual results may be better or worse.