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Best of the Web: Retirement Income Planners

October 2010

Picking Stocks

Perhaps the biggest question facing most retirees is how much money they can safely withdraw from their savings in retirement without running the risk of going broke. This quarter’s Best of the Web reviews free online calculators that can help you figure out safe retirement savings withdrawal rates.

Monte Carlo Simulations

Over the past decade hundreds of retirement calculators have become available that purport to predict your safe retirement spending rates based on your current savings and the mix of stocks and bonds and cash in your portfolios. Most are based on a technique known as Monte Carlo simulation (aptly named after the famed gambling resort in Monaco on the French Riviera).

These Monte Carlo calculators have useful applications but are all based on possibly unrealistic historical data rather than forward-looking expectations for stock and bond market returns. Most simulations assume a withdrawal and spending rate, adjusted upward each year for inflation. Many calculators ask too few questions about spending habits or sources of other income. In fact, many retirees can and do adjust their spending up or down in any given year in response to changes in the value of their savings. It is common for people to adapt to even a temporary decline in their wealth by cutting back on discretionary spending or by taking a part time job thus allowing them to reduce withdrawals from their investment portfolios.

One of the better Monte Carlo simulators is available for free from T Rowe Price. It has all the problems inherent in this methodology, but at least the web site makes most of the assumptions clear in footnotes.

Flexible Input Models

There are now a couple of free calculators that use more flexible assumptions. One such calculator, dubbed Tip$ter helps you model different spending plans. It's a little cumbersome to use, but it does let you input a 'barebones, can't go any lower' budget figure.

Tip$ter also, very importantly, allows you to input realistic real (after inflation) returns for stocks. There are good reasons to assume that stocks will provide an average real return of about 6 percent or less per year. Bond market returns are likewise likely to be low—perhaps as low as one to two percent going forward.

Based on specific budget and return inputs the Tip$ter calculator makes projections of how long your money is likely to last. It also give you a projection of the median annual budget that the portfolio would support.

Another free and interesting software model is ESPlanner. The developer of this software is BU economics professor Laurence Kotlikoff. Like Tip$ter, it allows you to input expected returns rather than relying on historical data. It asks plenty of detailed questions on spending habits, lifestyle and assets so you can test different scenarios. The model assumes you will spend all your savings by the time you pass away. You can read more about Kotlikoff's approach in his book Spend 'til the End. His happy thought is that we are saving too much and spending too little in retirement. I'm not sure he's right, but he makes some very important points and his modeling is a useful counterpoint to more conservative approaches.

You can use software tools and projections like these to help you make some baseline retirement planning assumptions and also to adjust your spending or retirement savings withdrawal rates up or down depending on how your investments do, adding your emergency cash saving buffer in good years and backing off your spending and/or drawing on your emergency cash savings in bad years. This kind of ongoing, educated, flexible planning is the most reasonable way to manage your money in retirement.

Please note that ESPlanner is a web based tool, but Tip$ter has downloadable software works best with Windows XP and Excel 3.0. Both sites also have sections devoted to research on retirement and financial planning that make interesting, if somewhat technical reading.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Past results are not indicative of future performance. Outside sources used in this article are believed but not guaranteed to be accurate. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.