Fifth in the Thin Mint series of posts
Wherever you are on life's journey, you've probably wondered, "Will my money last as long as I do? What if ______ happens?" Even if you have a CFP®, a computer science degree, and boatloads of time, there's no way to know with 100% certainty. But Personal Capital's Retirement Planner is a surprisingly robust, highly configurable tool that offers up valuable insights with ease.
Easy to Use, Yet Highly Configurable
Retirement readiness is a function of a whole host of variables unique to each individual or couple, if combining finances. Personal Capital lets you configure all the important ones - almost. (More on this later.) This enables you to closely simulate your financial plan so you end up with a reliable model of how it will play out in real life.
To get you started, the Retirement Planner inherits personal and investment profile data (e.g. age, risk tolerance) if you've already specified it for, say, the Portfolio Checkup. The next step is to enter other key data: savings rate, retirement spending, Social Security, tax rate, inflation, life expectancy, etc. You can also create future income events (e.g. pension) and spending goals (e.g. trip around the world) to better reflect your expected retirement reality.
Beware! The saying "Garbage in, garbage out" might well have been coined to describe retirement planning analysis. Inputting overly optimistic or pessimistic data can dramatically skew the results. So don't retire tomorrow or resign yourself to a life of endless toil until you are confident your assumptions are reasonable, erring on the side of conservative.
Fortunately, Personal Capital provides some guidance. A tutorial in plain English walks you through the setup process. Strategically placed (i) information buttons throughout offer "just in time" definitions, clarifications, and hints. Interfaces for changing assumptions are readily accessible. All these features add up to make the tool highly configurable and easy to use, increasing the odds you'll get trustworthy results.
[Big fat disclaimer! I spent 10+ years practicing financial planning and wrestling with the world's least user-friendly piece of software to do just this sort of analysis. This may have distorted my perception of "easy to use" a little... or a lot. If you have doubts about your inputs or outcomes, see a financial planner!]
Once you finish inputting your information and turn the metaphorical crank, Personal Capital calculates how your plans are expected to affect the value of your portfolio over the course of your life. It runs 5000 different simulations, using industry standard Monte Carlo analysis. This allows it to project a "portfolio survival percentage," i.e. the chance your money will last as long as you do, for the most likely and worst case scenarios.
The information is presented in several different ways, including a summary blurb (e.g. "Great shape for retirement") and success percentage (e.g. "Chance of meeting goals 100%".) It also displays a Projected Portfolio Value graph showing net worth over time as well as income and spending events for both scenarios. On the iPad version, you can touch the screen at any point on the graph to see what your nest egg is projected to be in that year, e.g. age 97 best case $2,928,321, worst case $916,158!
If you're less lucky than our sample prospective retiree, you can see when the money runs out and get a sense of why. Perhaps there's a precipitous drop the year after the trip around the world?? If you see a steadier decline, you're probably spending more on an ongoing basis than the portfolio can sustain. The Monthly Spending Power (in retirement) graphic shows the gap between projected and desired spending.
Detail-oriented? The Cash Flow Table allows you to drill down to precise portfolio values, as well as cash inflows and outflows for each and every year of retirement. With all this information, you should have a pretty clear picture of your retirement readiness. OK. but what if you don't like the answer? Or what if you're just curious about your options?
Personal Capital allows you to run What If scenarios so you can see the impact of making different choices. What if you forego the trip around the world in favor of an Airbnb on Maui? What if you skip the $75,000 kitchen renovation, or get a $10,000 a year gig in retirement? What if you drive the old beater a couple/few years longer? The possibilities are endless.
What If scenarios are run in preview mode so you can get a sneak peek at each change without losing the base scenario. Or you can save your What If as the new norm. Only you can decide what lifestyle choices combine to produce the most appealing mix of benefits and trade-offs. Armed with the knowledge of what it will take to make your retirement dream reality, you are in a much better position to make it happen. That's the beauty of Personal Capital's Retirement Planner.
Alas, the tool's strengths - ease of use, simplicity, robustness - are also potential pitfalls. To deepen your understanding of how to interpret the results, read the disclaimer! It explains some of the trade-offs and assumptions Personal Capital makes to manage the tool's complexity. And here's where the "almost" in the second paragraph comes in.
Of particular note is the fact that it uses historical rates of return as the basis for its retirement projections. To balance this assumption believed by many to be overly optimistic, Personal Capital sets a higher-than-historical default inflation rate, thereby reducing real returns. It also makes blanket assumptions about income taxes to avoid dealing with the infinite if's, and's, or buts of our tax code.
As previously discussed, some of the other default data Personal Capital conveniently provides (e.g. life expectancy 92) may not make sense for you. On the other hand, tweaking variables without understanding the implications (e.g. reducing your tax rate from the default 20%) could lead to equally problematic outcomes.
Further, the specificity of the results shown when drilling down to details makes the process look far more precise than it is. Don't be fooled! Assessing retirement readiness is part art, part science. This is true for any retirement analysis, not just Personal Capital's. No tool can make up for the uncertainty inherent in financial markets - and life; hence, the earlier advice to err on the side of conservative, run multiple "what if" scenarios, and periodically rerun the analysis.
Personal Capital's Retirement Planner isn't exactly like having your own crystal ball but it is a tremendously valuable tool. You'd be hard-pressed to find a better illustration of the concepts "time is money" and "information is power." And you can't beat the price ($0)! Even if you're already working with a financial planner on retirement readiness, running your own numbers with this app might be just the thing to deepen your understanding, strengthen your commitment, and accelerate your progress toward your financial goals.