A chain saw can be a very powerful tool, but it can also be extremely dangerous if used improperly. Retirement calculators can be similarly powerful and dangerous. Based on perceived major weaknesses of commercially available software tools, Kyle Financial Services developed a proprietary cash flow modeling tool for retirement cash flow simulations and asset allocation illustrations. Following is a summary of perceived major weaknesses of conventional tools that led us to develop our own proprietary tool:

1. Failure to adjust asset mix over time to reflect declining risk tolerance with age.

The single, greatest weakness of conventional cash flow tools is the failure to allow adjustments to the asset mix over time. This assumption is dangerous because, in practice, most investors reduce their allocations to stocks over time to reflect declining risk tolerance with age. Since stocks generally earn substantially higher returns than bonds, failure to reduce the allocation to stocks over time results in unrealistically high assumed rates of return. When projecting cash flows over several years or decades, the effects are compounded and can be quite dramatic. Our proprietary model incorporates flexibility to adjust asset allocation mixes over time to reflect declining risk tolerance with age, resulting in a more realistic depiction of returns that are likely to be realized over time.

2. Use of constant growth rate

We all know that markets do not grow at a constant rate. However, some models still simplistically assume that investments grow at a constant rate over time. This problem can be alleviated through the use of “Monte Carlo” modeling by which we simulate how portfolios might behave under thousands of different market cycles. In doing so, we do not profess to predict the future, but Monte Carlo modeling essentially “stress-tests” your portfolio to gain assurance as to whether your assets can sustain you through thousands of potential market cycles.

3. Use of unrealistic return assumptions and failure to consider investment expenses.

When it comes to software tools, many are familiar with the phrase “garbage in, garbage out.” This exemplifies the importance of using realistic inputs for any retirement cash flow projection. When projecting cash flows over several years or decades, the effects of return assumptions are compounded and can be quite dramatic over time. Many packages completely ignore investment expenses (e.g. advisory fees or fund expenses) that have a meaningful impact on net investor returns. Using our proprietary cash flow modeling tool, Kyle Financial Services employs reasonable estimates of return and volatility based on decades of market history, and incorporates investment expenses to reflect “real-world” costs of investment management.

4. Failure to appropriately account for taxes

Surprisingly, many software tools do an extremely poor job of distinguishing the tax treatment of investment vehicles such as taxable accounts, IRAs and Roth IRAs. Kyle Financial Services recognizes that, not only are these vehicles taxed differently, but these tax differences have implications for investment policy. As such, our proprietary cash flow modeling tool incorporates taxable accounts, IRAs and Roth IRAs and has the flexibility to incorporate unique asset allocation targets for each of these investment vehicles.

 

 

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