For complicated historical reasons, I hold $13,000 in a locked-in RRSP with Great West Life. A few days ago, I received a "Year-End Retirement Illustration", shown over the fold. I read it and thought "That's so bad, it's bloggable."
What's wrong with it?
First, the estimated retirement incomes and investment returns are stated in nominal terms, even though the calculations assume a 2.5 percent inflation rate. A retirement income of $105 to $155 sounds like a pretty good return on my $13,000 - but with 2.5 percent inflation, in 30 years time $105 will only buy as much as $50 buys now. A person trying to answer the question "will I have enough to live on in retirement" needs to know their real returns - that is, how much they can expect to earn in a currency she can understand, like 2013 Canadian dollars.
A second thing wrong with this retirement illustration the way that probabilities are being used. I am told "there is a 90 percent likelihood that you may receive an annual return of 4.45 percent." I have absolutely no idea what that means. Does it mean that there is a 90 percent chance the returns will be 4.45 percent or above? A 90 percent chance of returns of 4.45 percent or above, and a 10 percent chance of me losing everything I've invested in a global financial meltdown? The hypothesis that nominal returns = 4.45 can be accepted with 90% confidence? I suspect this last interpretation is the correct one, but begs the question: what other hypotheses could be accepted with 90% confidence? That returns = 3.0? 2.0? The mean and variance of the distribution of estimated returns would be far more informative than this strange probability calculation.
A third issue I have with these retirement planning scenarios is that they are, to my mind, pure fantasy. There is a 50 percent probability, according to this information, that I may receive a net return of 7.15. Since the plan has management fees of 1.75 percent, this implies a pre-expenses return of 8.9 percent. Right now in the US the 30 year fixed rate mortgage rate is 3.52 percent. Great West Life figures that they have a 50 percent chance of achieving more than twice that rate of return? Seriously?
A lot of fantasies are perfectly benign, like my fantasy of canoing from my house to the Arctic Ocean. Sweet dream, but I know I'll never act upon it. The fantasies of investment planners are more dangerous.
To the extent that statements such as this one overstate the rates of return available through managed fund, they could cause people to misallocate their investments, putting too much in managed funds, and too little in, say, blue-chips in a self-directed RRSP, strip bonds, or other alternative investments (this is not financial advice, I'm not a financial adviser.)
Also, a person who anticipates receiving a 4.5, 6 or 7 percent rate of return on her investments may invest too little, underestimating the amount of money she needs to put aside to meet her retirement needs.
In the end, I just look at statements like the one above and think "I've got a PhD in Economics, and I'm interested in financial literacy and retirement planning. If I'm having problems working out the heck this means, what is the average person supposed to do?"