Online financial calculators offer a seemingly easy way to plan for major life goals like retirement and education

Financial calculators offer oversimplified projection and can come apart easily; why you must not take these as final word However, these tools rely on multiple assumptions about inflation and investment returns. Even small inaccuracies in these estimates can drastically alter the calculated amounts, potentially leaving individuals underprepared

As investors, we crave control over our financial goals and aspirations. We detest not being in command of our journey. Like an anxious mother, we fuss over the math. How much money do I need for my retirement and for the kids’ higher studies? How much should I invest towards these goals? However, not many of us can count on a trusted financial adviser to show us the way. So we turn to online financial calculators. With just a few key taps, these nifty tools help us magically get a fix on the numbers. But are these calculators really putting us on the right track or misguiding us with their instant remedies?

Online financial calculators are quite intuitive, helping you distill complex goals—retirement, children’s higher studies, house purchase—into a single figure. To arrive at that magic figure, the calculator will ask you to plug in a few numbers initially, along with some basic assumptions. For instance, a retirement calculator will ask you to feed in your current age and household expenses. Next, it will ask you to make certain assumptions regarding your life expectancy, future expected rate of inflation, expected return from investments before and after retirement, etc. After the variables are fed in, the calculator gets cracking and instantly presents a set of numbers.

Suppose you indicated monthly expenses of Rs.75,000 at age 35, expected to grow at 6% every year till retirement at 60. The financial calculator suggests you need Rs.38.6 lakh to support your lifestyle immediately on retirement. It further indicates that you need to target a sum of Rs.8.84 crore to sustain your lifestyle over the next 30 years. To fetch this sum, it indicates that you need to put away Rs.66,651 monthly starting today, if you expect to get pre- and post-retirement returns of 10% and 8%, respectively.

Minor deviations from estimates can upset goal math

The calculator has your retirement mapped out. This figure gives your financial goal a definite shape. However, experts warn that it is not as straightforward as these financial calculators make it out to be. First, there are multiple variables at the heart of the calculator. If one or more estimates go wrong, even if by a few degrees, the whole math goes awry. What happens if the actual inflation pans out at 7% instead of the 6% you budgeted for? You will now spend Rs.48.85 lakh in the year after retirement, necessitating a nest egg of Rs.12.77 crore at age 60 to secure your needs for the next 30 years. Just 1% higher inflation raises your required corpus by a staggering Rs.4 crore. The bigger target now implies that you need to commit a higher outlay or you risk outliving your savings by several years.

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It is very difficult to lay a finger on the pulse of your future expenses, particularly when these are projected several years into the future. Besides, your personal inflation can vary a lot from the headline inflation. “The newsprint suggests that inflation is at 5-6%, but you cannot use this figure for higher education or medical inflation, both of which are way higher,” observes Juzer Gabajiwala, Director, Ventura Securities. Your spending habits may also undergo big shifts with changing circumstances. Twenty years down the line, you might incur big spends on items or experiences you can’t even imagine today—a personal robot or pure air, perhaps. No financial calculator can factor this into the math. Similarly, returns may pan out very differently from what you have estimated. It is futile to expect past returns to continue into the future. More importantly, the returns are not always linear, contrary to how these calculators work. You simply cannot predict the exact pattern of gains or losses, or the order in which your investment returns occur. For instance, negative returns occurring later in your working years and/or early in your retirement life can upend the goal math. This is what is referred to as ‘sequence of returns’ risk. A calculator is not equipped to cover such a scenario.

Clearly, financial calculators do not work to an exact science. These are oversimplified and can come apart easily. Multiple variables at the heart of such calculators can go astray as both financial markets and personal circumstances cannot be predicted. Vidya Bala, Head of Research, Primeinvestor.in, remarks, “The risk lies in making multiple assumptions. The outcomes can change drastically if you get these wrong.” So, relying on financial calculators is fraught with risks. “These give an illusion of control, but the reality is that nobody can predict how things will pan out,” argues Gabajiwala.

Do not use them as the blueprint for your financial goals. At best, consider these as a rough sketch for your investment journey. Stay nimble and keep revisiting the goal math. Be conservative in your estimates to leave enough room for error, suggests Bala. “Estimates regarding returns or inflation should be rooted in reality rather than what you wish for. If you keep expectations low, you will automatically save more, compensating for the estimates going wrong,” Bala asserts.

This story originally appeared on: India Times - Author:Faqs of Insurances