Figuring out how much money you need to save for retirement isn’t easy. It’s no wonder that so many people turn to experts for help. For the do-it-yourself crowd there are online retirement calculators to help. Unfortunately, the precise answers we get from most of these calculators just give us the illusion of certainty.
For fun I imagined my 25-year old self using one of these calculators. A quick online search for retirement calculators landed me at Mackenzie’s RRSP Calculator. This calculator is a common type where you punch in some numbers including assumptions about inflation and returns and the calculator gives unrealistically precise answers about how much you need to save.
So now I’ll conjure up the 25-year old me to answer the calculator’s questions:
Current value of RRSP
That’s an easy one: $0.
Current RRSP contributions
I haven’t really started yet, but let’s say that I start saving $100 per month.
Years to retirement and number of years for funds to last
I can’t imagine being 65 and having worked all my life. Let’s say I retire at 55 and the money has to last 40 years.
Income required in today’s dollars
I’d like to have a comfortable retirement. On top of CPP and old age security, let’s say I’ll need $40,000 per year from my RRSP.
Rate of return
I hear plenty of people talk about making 20% or more on their stocks each year. I’d better be more conservative and just assume 15%.
All the reports I hear say that inflation is around 2%.
That was easy. Now click on “Next” to see what we get. Mackenzie’s calculator comes back with a few numbers in addition to the following message:
“Congratulations! Your savings plan will provide sufficient assets to meet your needs through retirement.”
Great news! It turns out that my $100 per month savings are enough to retire comfortably at 55. My savings plan is right on target.
Of course this is all nonsense. The most important element of this “savings plan” is its hopelessly unrealistic return expectations. I assumed that I’d make about 13% above inflation each year for the rest of my life. This won’t happen. Based on these same assumptions, saving $1000 per month would allow me to retire at age 38. This is just silly.
The lesson here is to be wary of any tool that gives the illusion of precision. Decisions about retirement planning are inherently fuzzy because future returns and inflation are not known. To use these calculators correctly, you have to make conservative assumptions about investment returns.
An entirely different way to think about retirement is to invest as much as you can in the best way you can and be somewhat flexible about your retirement age and retirement income.