- What is a retirement calculator and how does it work
- The limitations of retirement calculators
- The importance of considering inflation and fees
A retirement calculator can be a handy tool for finding where you are on your journey to retirement. But, like all tools, it has limits. If you don’t understand these limits, or you set the wrong financial goal, you’ll arrive at a much different destination by the end of your journey.
You wouldn’t use a chainsaw to hammer in a nail, and you probably shouldn’t use a hammer to fix a pipe. Tools have purpose, and they can be very helpful when used correctly. This applies to both construction and personal finance. One great example of this is the humble retirement calculator.
Retirement calculators – your financial GPS
Much like a GPS uses triangulation between satellites to figure out where you are and where you are going, a retirement calculator uses the information you provide to help you figure out the path to your retirement goal.
A retirement calculator asks you for a few personal inputs:
- Your current savings: This is your starting point. To determine where you’re going, the calculator needs to know where you are.
- How much you’re saving: Essentially, this is the speed at which you are moving towards your destination.
- Your retirement goal: This is your destination, and the most important part. This could be a lump sum portfolio size that you want to save, or an expected annual payout per year.
A retirement calculator might also ask you for an expected rate of return, or your investment style. This establishes how much your investments will grow over time.
Based on this data a retirement calculator can tell you if you’re on track for your retirement goals. However, what it doesn’t do is check if you’re going to the right destination, it just assumes that you know exactly where you want to go. This is why your retirement goal is the most important input in the retirement calculator – if you don’t have the right destination for your trip you’ll just get lost.
How to set your own retirement goals
To start with, there are serious factors the average retirement calculator might not take into account. You need to understand these limitations and how they can impact your retirement journey.
The first of these is inflation. Inflation is the long-term force that reduces the value of money. Typically only a couple of percent each year, it means the value of “today’s dollar” is worth a lot less in the future. We see the impact of inflation every day on purchases we make. The price of something today is usually higher than it was a few years ago. Inflation can significantly impact the long-term value of your savings. To see the impact of inflation over time, look at the Bank of Canada’s inflation calculator. Inflation impacts how big of a retirement goal you need to set, as the buying power of your retirement savings will decrease slightly with time.
The second factor a retirement calculator doesn’t take into account is fees. Like inflation, fees eat away at the long-term growth of your portfolio, and increase the time it’ll take to reach your retirement goal.
The fees you pay directly impact the overall investment return of your portfolio. Over time, that can add up to a big part of your future portfolio’s size. Check out the impact for yourself in our fee calculator.
A retirement calculator that doesn’t talk about inflation or fees is a lot like a GPS that doesn’t consider speed limits or traffic. It can still get you where you need to go, but you probably won’t be taking the fastest route to your destination.
Be sure to look at all the factors when planning your retirement journey. Learn the tools you can use to help you, such as a retirement calculator, but also learn what the limitations of those tools are. A bit of time learning today can pay huge dividends in the future.
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The information in this blog is for information purposes only and should not be used or construed as financial or investment advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied is made by Questrade, Inc., its affiliates or any other person to its accuracy.