13 January 2008
Online calculators are convenient, but in real life they don't necessarily have all the answers, writes Bina Brown.
Online calculators are fast becoming a standard feature on the websites of wealth management companies. But before you get too excited about your prospective borrowing power or apparently comfortable road to retirement, it might pay to understand some of the assumptions behind the calculations.A few standard parameters used to calculate something like "how much money can I borrow" can result in vastly different amounts and therefore expectations depending on the often hidden premises used. Similarly, to base future projections on past sharemarket performances could easily give someone the impression they were saving enough for a comfortable retirement when in fact there was a lot more work to be done.Superannuation, retirement and salary sacrifice calculators dominate the calculator space on superannuation websites, followed by life insurance, budget and investment.But search far enough and you will find the workings to help you calculate the impact of the co-contribution on superannuation savings, the impact of fees on retirement savings as well as home loans, children's education, life expectancy and margin lending.While the calculators might be valuable tools to help people budget, pay off their home loans faster or plan their retirement, their ultimate aim for those providing them is marketing.Actuarial and management consultancy Rice Warner says competition among super funds following the introduction of choice of fund means member retention, and attracting new members to funds is critical to a super fund's survival and growth. "As a result many new funds now have calculators on their websites to assist members and potential members with their retirement and financial planning," says its director Jeff Warner.Money Managers director Kevin Bailey shares the view that simulators will not negate the need for people to seek advice but rather will heighten the awareness of the issues involved. "Particularly younger people who are very internet savvy and have never thought about retirement savings or superannuation and have never considered seeking independent advice may visit the website as a first port of call in exploring these issues," Bailey says.HOW USEFUL ARE THEY?The Australian Securities and Investments Commission's acting executive director of consumer protection, Delia Rickard, says that every calculator attempts to model, and therefore to simplify, what can be a complicated situation in real life. This is especially the case in which calculators project future benefits from super or investing. "You can rest assured that in real life, the final result will be different from what the calculator projects," she says. "Calculators can at best only illustrate the effects of decisions you can control, for example, choosing a low-fee fund, topping up your super, paying off a loan early. The calculators do this by ignoring what none of us can control, for example, increases in interest rates, market ups and downs," she says.Every calculator makes assumptions, but ASIC believes that too often it can be difficult to find what the assumptions are.In 2004 ASIC acted to close down loan calculators on more than 100 websites of Australian financial institutions - including banks, credit unions, other lenders and finance brokers - which suggested that using a line of credit would result in the consumer paying off their home loan more quickly. The loan calculators produced a graph, comparing the time taken to pay off a standard loan with the time taken using a line of credit. DIFFERENT RATESHowever, the way the calculator was designed meant that extra repayments were credited to the line of credit but not to the standard loan and that the two had the same interest rate. Most lines of credit charge higher interest rates than standard home loans, so it was hardly reasonable to suggest that paying higher interest could pay off a loan sooner.There are no standards for web calculators, although the Institute of Actuaries of Australia has published a guidance note for its members about benefit projections.Jeff Warner says that several companies have elected to make calculators brief and without too many assumptions rather than be seen to be offering advice - when all that may be required is a disclaimer.Denis Orrock of Infochoice suggests consumers question the assumptions and the default rates used. A default investment return rate of 13 per cent a year - based on recent sharemarket performances - would make a considerable difference to someone's retirement savings when in fact a more accurate rate would probably be 7 to 8 per cent."Web calculators will push people to obtain further advice but even then they should be questioning the assumptions an adviser uses," Orrock says. Given the different results that calculators present to the same issue Orrock suggests people compare calculators, particularly for more complex financial products and investment choices.ASIC adds that the assumptions about inflation, investment returns and costs should match respected industry-wide sources, including government or professional bodies. If they don't are they reasonable and are they explained?ASIC also suggests looking at projected benefits, especially for long-term investments such as super, in today's terms. Future dollars, especially over periods of 15 to 30 years, will be worth far less than today's dollars.WHAT MAKES A GOOD CALCULATOR?* Reasonable assumptions* Clear explanations of the purpose of the calculator, its limitations and assumptions* Future values are in today's termsCASE STUDY* Every calculator employs a different set of assumptions. A retirement accumulation was projected using 14 calculators with the following parameters: current age 30; retirement age 65; current superannuation balance of $20,000 and a current salary of $50,000. The only contribution was the 9 per cent superannuation guarantee contribution levy. The range of calculated superannuation benefits (see graph) in today's dollars varied from $214,000 to $470,000. When presented in actual dollars the results quickly shot upwards of $500,000.