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Should You Trust Robo-Advisors in Your Retirement?

Harry November 11, 2024

Technology brings convenience to many sectors, and the situation is no different in the sector. retirement planning. Nowadays, there are all kinds of projectors, calculators, and simulators that people can use to create their own retirement plans. So why not? Artificial intelligence and robo-advisors can seemingly do anything.

But relying too heavily on any of these “high-tech” ways can be risky and naive.

This is because there are a lot of assumptions about the numbers behind the scenes. Sometimes information is oversimplified, or retirement planners may plug in numbers without adequate research, which can lead to inaccurate results and unfortunate financial consequences, bringing to mind the adage from the early days of computing: “Garbage in, garbage out.”

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making correct assumptions

Being overly optimistic or overly pessimistic is not a sound financial strategy in the long run. inflationmarket returns, tax rates, life expectancy, volatility, etc. and attaching these numbers to yourself. Historical averages and current conditions should be weighed carefully, and do so not with algorithms as the main guide, but with an experienced advisor who knows and takes into account the ebb and flow and can help you make smarter and safer assumptions; over or under living your retirement.

But the financial industry often tries to tell people that there is a specific “retirement number.” There is no magic number. Because there are so many parts to a quality integrated retirement plan that need to work together, it’s important to have a guide who knows how those pieces fit together outside of your situation. With the right advice, make sure you make the right assumptions about inflation, your income, investment, protection, tax, retirement expenses and succession planning. Don’t go in blindly and set yourself up to overspend/give or underspend/give.

Here are some assumptions to be careful about or cautious about, especially when working with AI-driven or AI-supported financial platforms or tools. Any of these assumptions could have a major negative impact on your retirement plan.

Inflation

Let’s say someone has a retirement lifestyle today where they think they’ll need $100,000 a year. They use a calculator and project an average annual inflation of 2.5% as a guide, projecting that figure out to 25 years of retirement. That $100,000 turns into the $185,000 they will need in year 25. If the inflation assumption changes from 2.5% to 3.5%, the future lifestyle 25 years from now will require about $236,000 instead of $185,000, which is almost 28% higher at that point. . Each year after the first year requires more money, so you’re planning for a larger need that’s cumulative and growing over 25 years.

How much will your retirement savings be worth years from now? Inflation affects the amount of savings you need, as well as the return on investment you need; therefore, it also affects the level of risk you need to take to achieve it. During Social Security benefits are adjusted loosely for inflation each year (and likewise Medicare It’s important to create an income plan that anticipates inflation over many years while allowing for adjustments for inflation increases that may affect your short-term budget (such as premiums and possible surcharges).

Look at your income sources to see how they react to inflation. Many people have a pension Income without cost-of-living adjustments. Moreover, many married couples have pensions to be reduced for their surviving spouses, but this is a completely different matter.

An experienced financial advisor can help you determine a reasonable long-term inflation rate, in part by reviewing inflation over past decades and looking at current trends.

market growth

Let’s say someone has $1 million in excess wealth that they don’t plan on spending in the near future, or perhaps ever. Let’s assume the compound annual growth rate is 6%. After 25 years the future value will be approximately $4.3 million. If the average return is 7%, that would be about $5.4 million. If I go at 5 percent, it’s about $3.4 million.

These are huge differences with only a slight change in assumption. If you misunderstand inflation or are irrational in making assumptions about expected market growth, you can fool yourself into thinking it’s okay. Or you may mislead yourself about living inadequately in retirement, being so conservative that you’re not using your resources to live and give as much as you truly can throughout your life.

The stock market’s recent growth is remarkable, but it is dangerous to assume that average annual returns will continue as they have since 2008. There is usually a reversion to the mean; We don’t know why, how, when or how long it will last. The point is that you need to be somewhat realistic and sober about this, and more importantly, the difference between assumed market returns and inflation needs to be reasonable.

Taxes

No one knows exactly where tax rates will go, but you have to do it. stress test your retirement plan’s sensitivity to higher tax rates. Knowing that not all assets are taxed the same, you need to have a withdrawal plan that reduces tax exposure. Look at the history of government debt and tax rates (we have more debt as a percentage of GDP than at any other time in history). When debt was high, tax rates also rose. highest today tax bracket 37%, the lowest is 10%. In 1946, when debts were at similar levels, the highest tax bracket was 91 percent and the lowest bracket was 20 percent.

Where is the government’s debt level going from the current level of 123% of GDP? And for the wealthy (the top 1%, 10%, 25%, or 50% of the population), what do you think the political powers that be want to do about your tax rates? It’s not just about assumptions, it’s also about proactive actions. There are actions that can be taken to better position yourself for what may happen next.

life expectancy

As it relates to life expectancy, most people have a good chance of living into their 90s. Let’s say we have a couple in their early 60s. According to them, the chance of at least one of them reaching their 90s is about 40%. So, given that retirement can last 30 years or longer, you need to make sure you have the answers to navigate the multitude of economic and market cycles. You don’t want to get this wrong. Nobody wants to extend the life of their money.

retirement expenses

This is where people need to be realistic in their assumptions. They need to “peel the onion” and look at more than just their average monthly expenses based on their bank statements from the past few months. Along with the trips and luxuries they plan, they also need to factor in major expected and unexpected expenses that arise from time to time, from repairs to health issues to helping out a family member. These need to be added to the normal annual lifestyle. It’s also important to consider how strongly you desire to leave a legacy, and if so, make sure there are assets set aside for that purpose.

volatility

A final note about volatility. Volatility can be devastating. In other words, when you’re building wealth and adding money regularly, volatility can actually be beneficial for a while. In retirement, the opposite can happen and become harmful. The important thing is to have some money that is not so volatile to use in volatile times. Therefore, you need to determine whether you want to test your retirement with more or less volatility and consider the distribution order.

Result: The human touch

Having an experienced perspective financial advice to R. It is very important. Advisors can help ensure that the assumptions made in retirement planning are sound, reasonable, and grounded in how you think about money. They can help you so you don’t set yourself up for over- or under-living in retirement.

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

Top-down (“back of the napkin”) and bottom-up (detailed cash flow model) approaches are both informative. In other words, a simple model and a complex model should reach a similar conclusion. When they do this, you know you’re probably on to something.

One final caveat: Every simulation or scenario is just that. A year later it is absolutely 100% wrong. Using and preserving wealth is very, very different from building wealth. That’s why it can be so helpful to have a guide or financial advisor to help you think about your situation both strategically and tactically, at least on an annual basis.

Dan Dunkin contributed to this article.

The appearances at Kiplinger 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 to provide and should not be relied upon to provide any tax, legal or investment advice. You are advised to seek the advice of a qualified professional before making any decisions based on any specific information contained herein. The specific tax consequences of any investment or strategy will depend on your specific tax situation.

This article was written by and represents the views of our contributing consultant and not by Kiplinger’s editorial staff. You can check consultant records at: SEC or with FINRA.

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