Should you trust robo-advisors with your retirement planning?

Technology brings convenience to many industries, and retirement planning is no different. These days there are all kinds of forecasts, calculators and simulators that people can use to plan their own retirement. And why not? Artificial intelligence and robo-advisors can seemingly do anything and everything.

But it can be risky and naive to rely heavily on any of these “high-tech” routes.

This is because there are a lot of assumptions behind the scenes that go into calculating the numbers. Sometimes the information is oversimplified or people retiring may enter numbers without sufficient research, which can lead to false conclusions and unfortunate financial results that are reminiscent of the adage from the early days of computer science: “Garbage in, garbage out.”

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Make the right assumptions

Being too optimistic or too pessimistic about inflation, market returns, tax rates, life expectancy, volatility, etc. and doing the math yourself is not a sound financial strategy in the long run. Historical averages and current conditions need to be carefully weighed, not with algorithms as your main guide, but with an experienced advisor who knows and takes into account the ups and downs and can help you make wiser and safer assumptions so you don’t end up at the bottom Whether you’re spending too long or too little in your retirement.

However, the financial industry often tries to tell people that there is a certain “retirement number.” There is no magic number. Because a quality integrated retirement plan has several parts that must work together, it is important to have an advisor outside of your situation who knows how these parts fit together. With the right advice, ensure you make the right assumptions about inflation, your income, investments, hedging, taxes, retirement and legacy planning. Don’t go in blind and prepare yourself to either overspend/give or underspend/give.

Here are some assumptions you should be careful or cautious about making, especially when working with AI-driven or AI-powered financial platforms or tools. Any of these assumptions can have a massive negative impact on your retirement savings.

inflation

Let’s say someone has a retirement lifestyle that they believe requires $100,000 per year today. They use a calculator and predict average inflation of 2.5% per year as a benchmark, which they extrapolate over 25 years of retirement. That $100,000 becomes the $185,000 they will need in year 25. If the inflation assumption changes from 2.5% to 3.5%, this future lifestyle would require about $236,000 in 25 years instead of $185,000, which is almost 28% more at that point. More money is needed each year beyond the first year, so you plan for 25 years of cumulative and growing needs.

How much will your retirement savings be worth in a few years? Inflation affects the amount of savings you need and also the investment return you need – so it also affects the amount of risk you have to take to get it. While Social Security benefits are loosely adjusted for inflation each year (as are Medicare premiums and possible supplements), it is important to create an income plan that anticipates inflation over many years while allowing for adjustments for increases in inflation Can impact your short-term budget.

Look at your income sources to see how they respond to inflation. Many people have retirement income that is not adjusted for living costs. In addition, many married couples have pension reductions for the surviving spouse, but that is a completely different topic.

An experienced financial advisor can help you determine an appropriate long-term inflation rate by, among other things, reviewing inflation over the past decades and looking at current trends.

Market growth

Let’s say someone has $1 million in excess wealth that they want to spend in the near future, or perhaps never. Let’s assume an average annual growth rate of 6%. Over 25 years, the future value would be about $4.3 million. If the average return is 7%, it is almost $5.4 million. If I assume 5%, it’s about $3.4 million.

These are huge differences for just a small change in assumptions. If you misunderstand inflation or your assumptions about expected market growth are unrealistic, you can mislead yourself into thinking everything is fine. Or you trick yourself into living too little in retirement by being so conservative that you don’t use your resources to live and give what you really could over the course of your life.

The stock market’s recent growth has been remarkable, but assuming that the average annual return will remain the same as it has been since 2008 is dangerous. Normally, a reversion to the mean happens – we just don’t know why, how, when or how long it takes. The most important point is that you need to show some realism and sobriety and, more importantly, the difference between assumed market returns and inflation should be reasonable.

Steer

No one knows exactly what the tax rates will be, but you need to stress test your retirement plan’s sensitivity to higher tax rates. You need to have a payout plan in place that reduces the tax burden while knowing that not all assets are taxed the same. Look at the history of national debt and tax rates (we have more debt to GDP than ever before in history). When debt is high, tax rates have risen. Today the highest tax bracket is 37% and the lowest is 10%. In 1946, when debt levels were at similar levels, the highest tax bracket was 91% and the lowest was 20%.

Where is the national debt currently at 123% of GDP heading? And what do you think the political forces want to do for wealthy people (the top 1%, 10%, 25% or 50% of people) with your tax rates? It’s not just about assumptions, but also about proactive action. There are steps that can be taken to better prepare yourself for what lies ahead.

Life expectancy

When it comes to life expectancy, many have a good chance of making it well into their 90s. Let’s say we have a couple in their early 60s. There’s about a 40% chance that at least one of them will make it into their 90s. So you need to make sure you have answers to deal with numerous economic and market cycles, as retirement may last 30 years or longer. You don’t want to misunderstand that. Nobody wants to outlive their money.

Retirement expenses

Here people should be realistic with their assumptions. You’ll need to “peel the onion” and consider more than your average monthly expenses according to recent months’ bank statements. They need to consider both the expected and unexpected high costs that arise from time to time – from repairs to health problems to helping a family member – in addition to the trips and luxuries they plan. These must be added to the annual normal lifestyle. It’s also important to think about how much you want to leave a legacy, and if so, make sure there are assets set aside for that purpose.

Volatility

A final note on volatility. Volatility can be overwhelming. In other words, as you build wealth and add money regularly, volatility can actually be helpful for a while. In retirement it can be the other way around and become harmful. The key is to have some money that is not so volatile to use during volatile times. So you need to decide whether you want to test your retirement with greater or less volatility and think about the order of distribution.

Conclusion: The human touch

The experienced perspective of a financial advisor is crucial. Advisors can help ensure that the assumptions you make when planning for retirement are sound, reasonable, and based on how you think about money. They can help you so that you don’t have to live too much or too little in retirement.

A good advisor will stress test your plans and then make some adjustments to increase confidence. This isn’t just a one-time effort, as most customers tend to change over time, and as they change, their financial needs also change.

Both the top-down (“back of the napkin”) and bottom-up (detailed cash flow model) approaches are insightful. In other words, a simplified model and a complex model should produce a similar result. When they do, you know you’re probably on to something.

One final note of caution: Any simulation or scenario is just that. After a year it will definitely be 100% wrong. The use and preservation of assets differ greatly from the accumulation of assets. For this reason, it can be extremely beneficial to have a counselor or financial advisor at least once a year to help you think through your situation both strategically and tactically.

Dan Dunkin contributed to this article.

The Kiplinger appearances were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.

The information contained herein is for educational purposes only. It is not intended as, and should not be relied upon as, tax, legal or investment advice. You are advised to seek the advice of a qualified professional before making any decision based on the specific information contained herein. The specific tax consequences of an investment or strategy depend on your specific tax situation.

This article was written by and represents the views of our contributing consultant, not those of Kiplinger’s editorial team. You can check the consultant documents with the SEC or with FINRA.