Beware of fantasy thinking while saving for retirement

Have you ever gone to one of the free online savings calculators to see how much you might have accumulated when you finally retire? The calculators ask you to put in some numbers, such as your starting balance, annual contributions, and when you plan on retiring. You are also asked to guess an annual rate of return on your savings. Let's say you plug in a 4% annual return. Disappointed? How about 8%? Much better. Ten percent looks great!

Playing with rates of return is usually a harmless exercise. But a recent article in the Washington Post about Silicon Valley Bank illustrates the risk of changing assumptions with wishful or fantasy thinking.

According to the article, SVB executives decided in 2020 to boost profits by investing in higher-yielding longer-term investments. The strategy triggered an internal alarm: Bank earnings were at risk if interest rates climbed. Instead of heeding the caution and acting to mitigate potential risks, executives simply changed the model's assumptions to one more favorable to what they wanted. Oops.

The free online retirement calculators aren't very good. The results can vary significantly, depending on the underlying assumptions built into the model. Their value lies less in the results and more in that they reinforce the message it pays to start saving early. The magic of compounding over time even at conservative rates of return are impressive.

If the "saving early" moment is long past, the calculators can also help you put some numbers on how much to start saving. The longer you wait, the more important it becomes to set aside serious sums of income. "The biggest driver of your financial plan is going to be your savings rate," writes Bob French, director of investment analysis at Retirement Researcher and McLean Asset Management.

You don't have enough time to rely on the market's magic of compounding the closer you are to your retirement years, he adds. You also want to avoid the temptation of assuming really good returns to bail you out. That kind of wishful thinking compounds financial risks rather than mitigates them. Think SVB.

The good news is the closer you get to retirement the better data you have to work with to create a realistic plan. You will know your expenses and likely tax rate. You will have a realistic idea when to file for Social Security. You will also know how much you have saved for retirement.

Chris Farrell is economics contributor to the Star Tribune, Minnesota Public Radio and American Public Media's "Marketplace."