The proliferation of online calculators has been amazing. It is easy to find numerous calculators on line to help you with almost any question. They are useful in that they generate simple answers to complex questions, and yet that same characteristic means you should use them very carefully.

In general, calculators are like the proverbial black box. You answer a few simple questions, the calculator performs a few calculations not understood by you and spits out an answer. Unfortunately there are a few problems with this approach.

First, is the garbage in/garbage out phenomenan. The answers to the simple questions have a big impact on the outcome. If they are garbage, or even sometimes slightly wrong, the answer is garbage. Often, default answers are provided. Unfortunately, these answers may or may not be applicable to your situation. Even if you provide your own answers, they may well reflect only your best guess rather than the actual facts.

Second, the black box may well have all sorts of assumptions hidden inside, which may, or may not, reflect reality. And these assumptions can have a significant, but not understood, impact on the answer.

Let me take a few examples I have experienced.

Recently, I was considering whether to execute some incentive stock options and happened upon a calculator designed to help decide whether to execute or keep these options. I dutifully answered questions about what I would expect to earn on proceeds from the options and how much appreciation I expected on the underlying stock. Since anything I put would be a guess, I entered the same figure for each. Magically, out pops tables and charts showing clearly that I would be better off to not execute the options. It all looked very ironclad. But ultimately, I realized that with this was very questionable, and given this set of assumptions the answer was obvious, despite all kinds of assumptions about tax rates, etc. Since options are leveraged, any positive appreciation equal to normal investment expectations would favor the leveraged investment. However, after looking at several different sets of assumptions, I realized that the options were much more risky that the other potential investments. And, since I was within one year of option expiration, I didn't have time to ride out any short term setbacks. I decided to execute the options.

In another case, I was within a year of early retirement when I saw a calculator to determine what I needed to do to retire. I entered assumptions about how much I planned to spend annually in retirement, what rate of return I expected, my planned retirement date. The calculator returned with notice that I needed to save $100,000 annually to be able to retire on that date, which of course was not in the cards. My dream was shattered... but wait, if I lowered my spending expectations by 1%, magically I could retire immediately. Or, if I increased my assumed return by 0.1%, I could retire. The answer was right according to my assumptions, but minor changes made a huge difference in the outcome.

So, what should you do? If you want to take advantage of the calculator, make sure you take a number of steps to understand better the outccome you receive. First, take the output of online calculators with a grain of salt. Second, try to understand what assumptions may be built into the model, and whether they are appropriate. Then, run a number of different assumptions that cover the entire range of possibility so you have an idea of the sensitivity of the model to the assumptions you make. Be even more careful if the calculator is designed by someone trying to sell you something. It almost certainly has hidden assumptions that tilt the answer toward their product.

My personal preference is to do my own calculations. Generally, the calculations in the calculator are easy to model in a spreadsheet and can be set up within a few minutes. I set up the assumptions in a table and write formulas with use the cells in those tables. By doing this, you will have a good understanding of the assumptions that are the basis for the answer you are getting and can easily change the numbers in your assumption table to run sensitivities. This approach may take a few minutes longer than plugging guesses into a calculator, but you'll have a more better understanding of the complexities in arriving at an appropriate answer to your questions, and much better chance of arriving at the correct answer.

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