Online Financial Calculators
By Richard B. Dull and Lydia L.F. Schleifer
Making the Most with Online Financial Calculators
There are many financial calculators one can find on the Internet, all promising to help users with their personal financing, homeownership issues, or investments. But how reliable are these calculators? What features should users look for? The authors provide some caveats and sort through the myriad of options available. They also guide users through the process of working with online financial calculators, from choosing the right calculator, to double-checking results, to collaborating with a financial advisor.
Online financial calculators can be helpful in financial planning, but be careful when making critical decisions based on their output. Users might expect two calculators claiming to compute the balance in a savings account at retirement to provide the same results, a conclusion that may not be correct. Consider the following example:
When using the following parameters—a 45-year-old, with a life expectancy of 85, planning to retire in 20 years, needing $70,000-per-year retirement income (see Exhibit 1 for a full list of parameters used)—a sample of online financial calculators indicated required savings at retirement to be anywhere from $800,000 (using a calculator from a popular business publication) to $1,300,000 (using a calculator from a brokerage firm). What caused the difference? On the surface, it was not obvious, but after trying several sets of parameters, it became clear that the inflation rate variable on the brokerage firm’s calculator produced extremely volatile results.
Users must understand the basic concepts of calculators to understand why differences such as this exist. This understanding may not be possible unless the provider of the calculator discloses the assumptions made in its development.
What Are Online Financial Calculators?
Online financial calculators are software programs or electronic spreadsheets that allow users to input data or estimates and obtain the result of a calculation. Examples include programs that provide the predicted value of an investment portfolio, the amount of a loan payment, or the future cost of a college education. Frequently, calculator users are allowed to change many assumptions and see the outcomes under various “what if” scenarios. The Internet has made these programs available to any user willing to search for one.
Typically, business publications, brokerage firms, and other organizations or individuals with financial connections provide the calculators. Many calculators are associated with recognizable names; others are more obscure.
Reliability of Calculators
To start assessing the reliability of a financial calculator, consider the source of the program, including the possible objectives of the provider. The website that the calculator is associated with may indicate something about its reliability; users can generally expect widely respected organizations to provide reliable information to the public. A government website (for example, www.ginniemae.gov) that does not market to the consumer may provide calculators that are more independently reliable. Other sites of companies that do not market products but have a mission to disseminate information (e.g., www.finaid.org), or companies that are in the business of selling software (e.g., www.timevalue.com), generally have no vested interest in a particular outcome of a user’s decision. Users should also consider whether the calculator was developed by the provider or by a third party. If it was developed and sold by a third party, the program was probably independently tested.
In addition to being aware of the type of website hosting the calculator, and who developed the calculator, the complexity and flexibility of the calculator is an important consideration. More complex calculators may be more difficult to use but provide greater precision or realism. For example, more complex calculators might consider issues like inflation or the tax effect of different scenarios or decisions; these results will be more precise and probably more realistic than simpler programs. Remember that this precision is still based on estimates and will be no better than those estimates. More flexible or complex calculators will require more data and therefore require more estimates and judgment. A more precise answer is not necessarily a more accurate answer.
Another issue to consider is accuracy. Calculators do not necessarily disclose the underlying calculations that are used. Why risk retirement savings on a free calculator? Whenever making a critical decision, a good strategy is to pick multiple calculators that provide the same types of information and see if they produce the same results. A second, third, or even fourth opinion can only help.
Finally, the choice and use of calculators should take into account the sophistication, education, background, and experience of the user. Financial advisors can guide their clients to calculators that are appropriate for their situations.
Types of Calculators
There are many types and categories of calculators (see Exhibit 2). Generally, in investment and retirement categories, there are programs to help determine the investment required to reach a certain financial goal. Calculators can help users decide investment strategies, and whether they will meet their goals with such a strategy. In addition, some programs help analyze traditional and Roth IRAs or other types of retirement investment accounts, and calculate amounts of withdrawals possible, amounts of deposits needed, or the effectiveness of conversions.
Savings calculators can help users figure out how to save to reach a certain dollar goal or how much can be saved at a particular income. They can also calculate how taxes, inflation, and different rates of return will affect savings.
Budgeting calculators can help users figure out how to live within their income, pay off debt, budget for emergencies, and estimate the cost of raising a child. For example, USA Today provides a budgeting calculator on its website. The calculator includes questions such as “Should I pay off debt or invest in savings?” and “What’s it worth to reduce my spending?” Each question is linked to a calculator represented by three categories: inputs, results, and explanation. Exhibit 3 shows the inputs for the “What’s it worth to reduce my spending?” calculator. The results then show how much can be saved each year, how much accumulates in 10 years (after taxes) if invested, and how much has accumulated at retirement if invested in a tax-deferred account. The explanation briefly points out that this calculator demonstrates how savings can accumulate over time if invested.
Debt calculators help users figure out how to pay off a credit card balance, whether to consolidate debt, or how to make choices between financing depending upon the terms. In addition to debt management, home-financing calculators can help one choose between fixed or adjustable rate loans, or between renting and buying.
Another group of calculators is designed to help with college planning and savings. T. Rowe Price Associates includes a college investment calculator on its website (www.troweprice.com) that uses a “Monte Carlo” simulation which weights possible outcomes to assess the likelihood of reaching the goal of paying for college. The site includes a description of the method of analysis. The calculator includes information about hundreds of colleges and universities and requires information about estimates of financial aid and other sources of financing to be input.
College planning calculators are not limited to financing. BusinessWeek provides a calculator to compute the return on investment (ROI) for business schools in order to decide which university to attend for an MBA degree (bwnt.businessweek.com/roi/enter.asp). The calculator first asks for seven pieces of information from the user. The opening page shows an example of the spreadsheets that will result when the calculator is used. Schools with one-year and two-year MBA programs are listed, and for each, there are five pieces of information calculated. After requesting to “calculate again,” the user gets to choose the schools of interest and to make the seven choices shown in Exhibit 4, which also lists the results.
A sampling of other websites that provide online calculators can be found in Exhibit 5.
Advice and Caveats
Calculators produce hard numbers, but these numbers should not be considered scientific. It may be impossible to assign value to inputs with absolute, 100% certainty. For example, the exact age at retirement may still be unknown for someone using a calculator to determine a savings strategy. In general, when uncertainty exists, one should make several calculations using different values for parameters such as retirement age, and then evaluate the results.
Calculators have significant limitations. Read the disclaimers that accompany online calculators. Frequently, the user is cautioned to “obtain personal advice from qualified professionals.” This is where an accountant can provide assistance.
Accountants, especially personal financial planners, can guide individuals through the labyrinth of available calculators. It is important for users to realize that these calculators, although seemingly useful, cannot replace the resources provided by a financial advisor. Getting acquainted with, and even using, financial calculators should be a collaborative effort, so their use does not lead to bad decisions.
How can an accountant help clients in an environment where online financial calculators are accessible to everyone? They can start by making sure their clients examine relevant questions regarding the calculator. Accountants can review for reasonableness the assumptions the client made when using the program. They can also suggest getting a “second opinion”; that is, recommending that the client verify the results with another site.
Financial planners can provide tested calculators on their own websites. Several companies offer suites of calculators that can be customized, and their computations, updates, and development issues are completely automated. An online calculator can also benefit an accountant by getting his name in front of a client making a financial decision.
As professional advisors, accountants want to be associated with their clients’ successful decisions. Helping with financial calculators may help accountants achieve that goal.
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