Online Planning: Rolling the Dice

I recently read an article that suggested that you can manage your financial life using free websites in as little as three hours.  Wow, imagine mapping out your life for free in three hours.  Anyone who has read my previous posts knows I’m a strong advocate for do-it-yourselfers.  We all need a little help, and the internet has become a cornucopia of self-help.

So I did a little test:

Google “Free Financial Plan” and choose a likely tool. Enter income and expenses, assets and long-term debts.  You can also add projected retirement details, for instance how much you will receive from Social Security and/or a pension.  Add a few goals: wedding, new home, education. These tools even have a “What if” feature to account for unexpected occurrences.  Choose calculate and poof!  You see a “meter” measuring your probability of success.  My sample plan gave me an 80% probability of success.  Many of these sites will be glad to help you further by offering loans or investment assistance. 

So, what is in the black box and how are they calculating your success?  First, let’s look at your income.  Typically the input will say “salary,” but is it gross or net of taxes?  If you add net salary and the program assumes gross, the internal tax calculations will be off.  State income tax varies widely from zero to more than 13% depending on your state of residence.  Inflation historically has averaged over 3%.  Is inflation applied equally to your home value and your healthcare premiums? 

In my test, I’d entered expenses that exceeded my income, as well as small investments and a house.  Remember, the online tool told me I had an 80% success rate. Running the same numbers in a spreadsheet, with the same assumptions and calculations, I crash and burn.  The only way I could succeed was to spend the value of the house.  So yes, as long as I don’t mind spending my twilight years living on the street, I’ll be fine.  So why the disconnect? 

The Monte Carlo Simulation

The root of many of these calculators is the “Monte Carlo” simulation. This method samples random variables to return a probability of success.  Long used in mathematics and engineering, Monte Carlo is a legitimate tool for modeling of known variables.  Are investment returns known variables?  The Monte Carlo simulation pulls historical investment returns.  Historically, the S&P 500 has returned over 11% since 1970.  The MLP index, which measures oil and gas deliverables, returned 14.5% on average over the past 19 years.  The historical rate for a cash proxy was almost 4% in 77 years.  Try asking your bank to offer that interest rate.  So, with these underlying return assumptions, of course my online plan will look successful.

Online calculators can be quick exercises to support your financial direction.  But if you really want to plan your future, don’t depend on a roll of the dice.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice.  Please note that individual situations can vary.  Therefore, this information should be relied upon when coordinated with individual professional advice.