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Laura Rowley Money & Happiness

Laura Rowley, Money & Happiness

A One-Man Revolt Against the Financial Services Industry

by Laura Rowley

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Posted on Wednesday, July 2, 2008, 12:00AM

Larry Kotlikoff hates conventional wisdom.

In his new book, "Spend 'til the End: The Revolutionary Guide to Raising Your Living Standard --Today and When You Retire," the Boston University economist declares war on the financial services industry and its traditional advice.

Striking a Balance

It's an appropriate read for the Fourth of July weekend, because it demands a revolution in thinking about monetary decisions -- from where to live to how much to save for retirement to whether you should pay off your mortgage early.

"This was supposed to be a complete demolishing of conventional personal finance, because the standard advice is so at odds what economic science says," Kotlikoff says.

"Spend 'til the End," co-authored with syndicated columnist Scott Burns, advocates consumption smoothing -- adjusting your spending, saving, insurance, and asset holdings on an ongoing basis to maintain a stable living standard. The idea is to strike a balance between living it up now and starving in retirement, and sacrificing fun now to scrimp for the future, ending up with a mountain of cash you're too old to enjoy.

Addressing Personal Finance Malpractice

The book suggests that the choices you make about education, career, job, housing, retirement accounts, and insurance, among other areas, provide more money for the same effort.

"People are making mistakes on both sides -- 40 percent are under-saving and 30 percent are over-saving," says Kotlikoff, who has developed dynamic programming software called ESPlanner that makes consumption recommendations based on dozens of criteria. (I've tried it; I'm an over-saver.)

"I'm not making a living selling software," Kotlikoff insists. "I got into this because I got pissed off at seeing industry malpractice left and right."

How Much Do You Need to Retire?

In particular, Kotlikoff condemns income-replacement formulas suggesting you save enough to retire on 85 percent of your income. That number comes from a study sponsored by the insurance company Aon and is common in financial calculators, such as Fidelity's MyPlan.

"The right replacement rate could be 45 percent, not 85 percent," Kotlikoff argues. "That ratio is extremely sensitive to [the individual's situation], whether you have two kids or one, how old the kids are, whether your spouse works or whether you downsize your home in retirement. They all make a huge difference to the appropriate spending paths over a lifetime."

Parents who are paying college tuition at age 60, for instance, won't be doing that in their 80s, he points out.

Pimping Risk

Exaggerated savings goals lead to what Kotlikoff calls "pimping risk."

"The industry sets targets that are far too high and then says, 'Gee let us help you hit that target -- put your money in stocks,'" he says. "It is true that the probability of making your target will go up, but the probability of having a really bad outcome -- like losing your principal -- will also go up, and so will the fees charged for management."

Noting that three-quarters of active money managers don't beat the market's returns, Kotlikoff and Burns' book recommends that investors choose only low-cost, highly diversified domestic and international index funds -- and be prepared to stomach the market's ups and downs.

"Don't try to time the market because you don't have enough knowledge to do that, and even people with knowledge get burned," says Kotlikoff. "If you're really terrified about the market, buy TIPS [Treasury inflation-protected securities]. You won't do as well over time, but you won't lose your principal."

Asset Diversification vs. Resource Diversification

Meanwhile, if you do hold stocks, age-based allocation strategy scenarios suggest you hold more while you're young, because you have time to ride out the markets ups and downs, and then shift into safer assets like bonds as you age. Popular life-cycle and target-strategy mutual funds are based on this principle.

But Kotlikoff and Burns argue that investors should focus on diversifying their overall resources, not just their assets. Consider a 60-year-old who has $20,000 in assets and $20,000 a year in Social Security income. The latter is equivalent to holding $1 million in inflation-indexed bonds, with a guaranteed annual income stream of 2 percent of the principal, Kotlikoff notes.

"If you take the $20,000 in assets and concentrate it into stocks you will still be highly undiversified -- you are wildly into bonds," he argues. "So concentrating your assets in stocks is the thing to do."

Thus the 60-year-old with guaranteed Social Security payments should hold more stock than someone like me (in my 40s), because as a freelancer my income is more uncertain and I also face more potential liquidity constraints, Kotlikoff says. In their late retirement years, people should dramatically cut back on stocks, because that's when health care expenditures are most uncertain, he adds.

Critical Choices

"Spend 'til the End" also recommends people "price their passions," or calculate the living-standard effect before they get married, have multiple children, divorce, or move to a big city. For instance, the book extols the virtues of living in Cedar Rapids, Iowa (advice clearly conceived before the recent floods), because its low-cost environment provides a 78 percent higher standard of living than Seattle, and 34 percent higher than Tampa. (Stronger housing appreciation in the latter cities doesn't offset other costs, the calculations show.)

"It's important to make these choices ahead of time, to think about what really makes sense in terms of everything you want, because people do make critical, life-altering geographic decisions," Kotlikoff says.

I've actually thought of moving to Iowa (usually after my property tax bill arrives) because I have family there. My husband and I could probably retire 10 years earlier if we sold our home and headed to the Midwest. But living near New York City is an important part of our emotional living standard -- we have family here, too. And I can't fathom the rise in living standards required to get my husband to give up his Giants tickets.

Sometimes, maximizing your self-interest goes beyond calculators. In this case, I'd prefer to leave the price of my passion out of the equation.

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  • Yahoo! Finance User - Sunday, July 13, 2008, 11:54AM ET  Report Abuse

    • Overall: 4/5

    Studies show that rooting for New York sports teams actually lowers your standard of living.

  • Yahoo! Finance User - Wednesday, July 9, 2008, 2:14PM ET  Report Abuse

    • Overall: 1/5

    1. I would rather be conservative and die with a little too much money than no money at all. I don't want to burden my children. 2. Anyone who says they can predict future costs is selling snake oil. There is enough bad advice out there. Books like this do not help The average American saves not nearly enough. See http://www.fool.com/personal-finance/retirement/2008/07/08/prepare-for-a-gruesome-retirement.aspx

  • R A Bottens - Wednesday, July 9, 2008, 9:53AM ET  Report Abuse

    • Overall: 2/5

    This is where we see the difference between the have's and the have nots. Laura's advise might work for the extremely wealthy but do not work for the few of us who remain in the incredible shrinking middle class. But we need someone who can write good retirement advise for those with salaries/incomes in the $50,000 range who struggle to make ends meet on a regular basis. Most of the information in this article misses the needs of the middle class. oversaving? our savings rate decreases every year as more and more fund their expenditures on a credit card. I began my financial planning back in 1977 when I got married. The plan didn't project oil would reach $150 or gasoline $4 . It didn't project how much the cost of education and healthcare would skyrocket. With the inability to effectively predict the future how can you oversave? In fact how can you even manage to keep up with inflation? A better approach would be to look at the what you are spending now and how that spending will change when you reach your targeted retirement date. House payment for example will it be gone by the time you retire? That will reduce your expenses considerably. Insurance cost will increase if you retire early as most employers pick up a part of your health insurance but will decrease when you get on medicare but you will need to purchase a medicare suppliment but it will be less than regular health insurance. Putting kids through college should be completed and monies spent in that area should reduce. Medical cost will increase as you grow older so plan accordingly. One of the best ways to be prepared for retirement is to have some alternate income streams flowing to help you maintain your living while not working in the public sector. A good example might be a small family run business or rental properties etc. I am going to be using procedes from my family farm and rental properties to suppliment my retirement income and social security if it is there when I retire. I do not plan to retire before the age of 70 so I can draw the maximum SS benefit. If SS isn't solvent by the time I retire I should still be ok as I have planned on it NOT being there. I feel anyone retiring from work should be able to do so with dignity. It is hard to plan for everything and if you do spend a little more on yourself along the way really how much will it impact your retirement? The people who retire early will have to be more cautious as to how they spend in retirement than those who decide to retire later in the ball game. As far as inflation rated treasuries, our government lies about the rate of inflation anyway so it means that your money will not keep up with your required spending. Just gasoline alone have compounded the annual inflation rate because our government chooses not to include it. Smart choice because if it were factored in the government couldn't keep indexing increases in SS without bankrupting it much sooner. By the time you get ready to cash out your 401K your government may choose to apply a tax on it, don't be surprised by anything the government does. Even the most careful planner will have difficulty anticipating the changes our government can make over the next 20/30 years. After all we have to bail out all those failing banks some where down the futuristic road. That burden will fall on the incredible shrinking middle class American to whom this article really does not apply. Happy retiring. :-)

  • George - Tuesday, July 8, 2008, 3:38PM ET  Report Abuse

    • Overall: 5/5

    First I think it's great that people understand that their retirement is up to them. Save what you can and make up your own mind when it's time. If you don't plan for your retiement who will? The Government? Your boss? I'm retiring at 55 and making the cuts that that need to be made and plan on working part time for any extras I feel I need. Doing my own investing with having fun as the number one most important thing. I've been thinking retirement since I was 45 and lived on as little as I could and still be happy. It has worked and I realize just how little I need. Wish me luck!

  • Marty - Tuesday, July 8, 2008, 11:57AM ET  Report Abuse

    • Overall: 4/5

    Good advice - sure. Revolutionary? Hardly. Use index funds and avoid high fees and expenses - I have been doing this for 25 years. Kotlikoff advocates it and hits the nail on the head - active management doesn't pay! I work in the financial industry and I can tell you from 25 years of experience - active management is designed to make money for the people who sell it, not the people who buy it. Period. End of story. Find a low cost place to live - Yep! Pay off your mortgage early to live debt free in retirement - Yep! Replace just 45% of your pre-retirement income? Be very careful about this one. Everyone is different. You should make a "retirement expenses" calculation using your current expense level and how it will change in retirement. Don't forget health care as it is a key expense as you age. The penalty for not saving enough is a lot more unpalatable than saving too much. If you save too much, you can relax your spending plans, give money to your children, or give it away to charity to do some good in the world. If you save too little, no that's going to be a problem.

  • J - Tuesday, July 8, 2008, 2:56AM ET  Report Abuse

    • Overall: 3/5

    hdaeniwd you don't know what you are talking about. A CD deposit is a liability for a bank; not a capital infusion. The point of the article is to save for retirement based on YOUR needs and not what some financial institution says based on some model. I'm a CFP and I think Kotlikoff is right on. By the way, check out Scott Burns money management firm. It makes sense to be a couch potato investor. Passive investing wins 9 times out of 10. The most important decision is the asset allocation (stock-bond-cash). That is where you can reduce or increase risk individually. I also agree with the Social Security point in the article but wish Bush's individual accounts plan would have passed.

  • J - Monday, July 7, 2008, 6:09PM ET  Report Abuse

    • Overall: 4/5

    I wonder why folks always want to paint democrats as tax-and-spend. Hell, they have to raise taxes to pay for the bills incurred by Dubya and the Republicans (wars, corp tax breaks, spiraling national debt, etc). You can't keep cutting taxes every year without suffering the consquences. No wonder people are in so much debt. That is the same type of logic that compels people to spend spend spend without regard for the day of reckoning when the bills come due.

  • Cwon1 - Monday, July 7, 2008, 4:16PM ET  Report Abuse

    • Overall: 1/5

    It's twaddle. Same infomercial financial planning dissent and an insult to prop up the self-promotion. It isn't your brokers fault you don't have enough saved to live as you do. It isn't your brokers fault you always m want the last best thing and chase bubbles. Typical liberal social culture; someone else is to blame.

  • Da Big Guy - Monday, July 7, 2008, 4:15PM ET  Report Abuse

    • Overall: 4/5

    A great attempt to preserve the distinction between wants and NEEDS!

  • Godfrey - Monday, July 7, 2008, 3:11PM ET  Report Abuse

    • Overall: 4/5

    Kotlikoff is right on the money. The financial services industry has a vested interest in getting people to save and invest more. This drives up their commissions, fees and compensation. Meanwhile, the average investor is losing money one bubble after another. The savings and loan debacle, the tech bubble and now subprime. The only constant through all of this is that the compensation of money and hedge fund managers has gone through the roof while investors keep losing money. This is a conflict of interest. These money managers should do well to remind people that losses on ROTH and 401k accounts are not tax deductible and early withdrawal attracts a 10 percent penalty and taxes. Too much risk/penalty for the potential payoff.

  • Baby boomer - Monday, July 7, 2008, 2:04PM ET  Report Abuse

    • Overall: 3/5

    I also question the fact that Laura gets her whole article from Kotlikoff's book but I assume that she agrees with his point of view. Yes you should strike a balance between spending now and saving for retirement but it is easier to get into a saving mode when young and begin to spend more when older than to spend when young and try to change your life style later. So over-save now. Then the 85% rule of thumb is just for the mentally lazy, dumb and an excuse for the planners and fund sales personnel to push more product. If you're over saving now, when you retire you no longer need to save and won't need 85% of current income. If you've been saving and investing from your mid twenties and been reasonably successful, why would you change your investments just because you retire? If you retire at 65, statistically you can expect to live to 80 but you could easily live to be 100 i.e for 35 years and you need the cash flow and you need to allow for inflation and big health care costs towards the end. Why would I move to Iowa just for a lower cost of living when when my salary would be about half of that in my current community? I don't have seasons tickets to Giants or any other team but surely that decision is part of juggling money & happiness. Money doesn't buy happiness, but lack of money can quickly create stress and unhappiness.

  • Ice - Monday, July 7, 2008, 1:42PM ET  Report Abuse

    • Overall: 4/5

    Good article. I think Kotlikoff makes some good points. There needs to be a better balance between current consumption and saving for the future. However, I disagree with his assessment of brokerage firms. These companies have to be conservative with their recommendations so, yes, they may want you to oversave (which gets them more $$ in fees). However, no matter how much you oversave, that extra money is still your money! Given a choice, would you rather have more money than you need or less?

  • seawolf - Monday, July 7, 2008, 11:36AM ET  Report Abuse

    • Overall: 1/5

    Now this is a book review not an article. Journalism please, this is not a book review club.

  • John - Monday, July 7, 2008, 11:01AM ET  Report Abuse

    • Overall: 1/5

    is Laura an associate of amzn???....90% of Laura's articles are all about the $$$$...."Launched in 1996, Associates is Amazon.com's affiliate marketing program. By linking to Amazon products and services you can add compelling content for your site visitors enjoyment and receive up to 15% in referral fees for doing so. "_______so much for journalistic unbiasness.

  • Kirk J - Monday, July 7, 2008, 7:40AM ET  Report Abuse

    • Overall: 2/5

    Kotlikoff, and another Yahoo financial blogger - Ben Stien, have been advocating life-time consumption profiles for many years. The primary drawback to Kotlikoff's version is the economist's knack for making assumptions. For example, we can assume at what age we will die within a couple of years, and we should calculate our comsumption to maximize our lifetime utility. If life were so predictable, then economists would be happy but the rest of us would be bored. While oversaving might result in some potential lost utility from consumption, there is utility in knowing the safety and security of a larger financial portfolio. There is utility in knowing that a "liquidity constraint" (running out of financial assets at any period of time) is less likely. There is utility in knowing that if I die early - missing out on some bits of utility because I saved an extra $50 a month these last ten years - my family will be better able to move on and my charitable beneficiaries will be all the more able to fulfill their missions. Perhaps I am abnormal in the eyes of economists since I derive utility from non-material aspects of having more wealth. Given the thousands of people I have dealt with over the years, I think more of us are like me than like Kotlikoff's auto-equilibrating, perpetual calculating, utility maximizing consumerists. The two stars are not for the columnist - keep up the good work Ms. Rowley. It is for the subject material. Kotlikoff is proposing nothing new, just a technological upgrade (computer software) to 30-40 year old consumption hypotheses that are available at your local library free-of-charge. Perhaps Kotlikoff is a better businessman than economist? - He is selling people a product that could be had for free.

  • Travis - Sunday, July 6, 2008, 10:43PM ET  Report Abuse

    • Overall: 1/5

    I don't agree that this is "revolutionary." One thing that the article doesn't mention about pricing our emotional needs is the comfort that gaining and achieving financial stabilty brings. Saving less could be the answer, but if I error, I sure don't want it to be on the careless side. Life in the older years might be very regrettable with poor preparation.

  • Reinhard - Sunday, July 6, 2008, 10:39PM ET  Report Abuse

    • Overall: 2/5

    What if life is not about maximizing "self-interest"?

  • Gene - Sunday, July 6, 2008, 8:42PM ET  Report Abuse

    • Overall: 4/5

    Agreed, fractional reserve banking needs to be racheted down quite a bit. As a saver I've seen my purchasing power wiped out. The bankers and investment firms are much worse than the credit card companies in the sense that they largely control the value of the dollar. They inflate it forcing you to speculate with your savings which of course they take a large continuos cut. By market capitalization the finanicals made up 15.9% of the S&P500 currently and 21.3% a year ago. This is really crazy if you think about it. In a very real aspect we are all slaves to the bankers. Even those of us not carrying personal pay interest in the forms of federal, state, and city debt and what I like to call the inflation tax. Point is that our culture as become more addicted to debt than oil.

  • Yahoo! Finance User - Sunday, July 6, 2008, 7:50PM ET  Report Abuse

    • Overall: 2/5

    I often find good info in Rowley's articles, but Kotlikoff is just another guru windbag spewing nonsense. Save all you can, it still won't be enough if our banks are allowed to continue fractional reserve lending.

  • Yahoo! Finance User - Sunday, July 6, 2008, 5:42PM ET  Report Abuse

    • Overall: 4/5

    Bad, Bad advice. Impossible to oversave. Retirement income should be 100% of Age 40 income. Consider unbelievable increases in medical costs, plus inflation, plus costs of hiring needed sevices you could do yourself at age 40. From the viewpoint of 83 year old looking back. retirement

  • DennisAOK - Sunday, July 6, 2008, 3:22PM ET  Report Abuse

    • Overall: 4/5

    Thanks for ther review, Laura, but I intend to go right on living below my means and saving a lot. I like having cash in the bank - I sleep well at night and that allows me to won stocks for the long term. Regrettably, too many people in this country live above their means and then complain about "the rich" ripping them off, or about society owing them a living.

  • Yahoo! Finance User - Sunday, July 6, 2008, 3:19PM ET  Report Abuse

    • Overall: 4/5

    This is good. So called financial experts should have to show their conclusions with numbers under realistic conditions. If they did, most would fail miserably. The 80% of pre-retirement income is still widely quoted, but as pointed out could fail miserably. It does seem to be coming around though, only stated by the most stupid, lazy, or incompetent.

  • David - Sunday, July 6, 2008, 11:07AM ET  Report Abuse

    • Overall: 3/5

    No argument with Laura's summation of the text in question; however, Kotlikoff apparently forgets that money is power. With the majority of American's living within the middle-class salary range, those with great savings have more options and power than those who don't save. I agree, the 80% of salary at retirement is too high, a 40 - 50% of salary at retirement will be fine with those with no debt, and no looming expenses, such as a child's college or medial expenses. Money = power. Go onto a car lot a pay cash for your next vehicle, or for your next home, that's powerful (although not always the best financial decision, I'll leave that to you).

  • JerryS - Sunday, July 6, 2008, 8:36AM ET  Report Abuse

    • Overall: 1/5

    Although the story describing the book was written well enough, the premise of the book itself sounds terrible. The author should donate all of his book proceeds to help the people that follow his irresponsible advice. This book will only help the people that are already living financially irresponsible to justify continuing to do so. Sad, really. This book makes it sounds like you have failed in life if you haven't spent every penny of your money before you die. My philosophy is that if you live longer than your money you will surely know it but if you die and still have some money you will simply be dead and not realize that you you were screwed out of spending another dollar. The "spend more, save less" mentality of this book is exactly why our country is in the poor financial condition it is in. People want to cry about the "Oil Crisis" but what about the "Irresponsibility Crisis" that exists in our society and that this book helps fuel? Live with balance, for today and for tomorrow, be truly happy.

  • Yahoo! Finance User - Sunday, July 6, 2008, 7:00AM ET  Report Abuse

    • Overall: 4/5

    Reminds people to think about retirement and that most should avoid the stock market except for index funds. Good stuff. The idiot below who says banks lie should talk to a broker to hear real bs.

  • James - Sunday, July 6, 2008, 6:36AM ET  Report Abuse

    • Overall: 1/5

    another self fullfilling article. no more of my time is worth spending writing a longer response

  • Yahoo! Finance User - Sunday, July 6, 2008, 3:51AM ET  Report Abuse

    • Overall: 2/5

    Going against conventional wisdom in the case if saving to retirement could prove to be a very bad decision. Unless there is proof beyond reseanable doubt that Kotlikoff's approach works, It is more like gambling with your retirement. I agree with Laura that not all things in life can be measured in dollars and cents.

  • . - Sunday, July 6, 2008, 3:14AM ET  Report Abuse

    • Overall: 2/5

    Wish that these columnists would get practical. I've been speaking to banks that are lying to depositors, telling them that each CD in their name is FDIC insured to $100,000 and that is just not true. Banks are desperate for capital (deposits) and it seems that the old song "Liar liar pants on fire" is still playing. Lenders lied to mortgagees. And now, banks are lying to depositors. Tell people about the nuts and bolts of protecting themselves from these lying sharks! That is more important than more of these idiotic fictious portfolio strategy stories.

  • AlwaysCorrect - Saturday, July 5, 2008, 11:08PM ET  Report Abuse

    • Overall: 2/5

    Although I agree you need to balance life with savings, the remainder is pointless. Dear BU economist, TIPS? Are you kidding me? This advice makes the gold hawks I mock seem intelligent. Please, provide us with some proof of your claims, otherwise keep teaching and let the rest of us that 'do' keep 'doing' . I'm not even going to touch on relying on SS income.

  • Yahoo! Finance User - Saturday, July 5, 2008, 12:47PM ET  Report Abuse

    • Overall: 4/5

    The second-to-last paragraph is my takeaway. Personalizing the reaction to the book. I liked this review very much, the subject interests me and I will buy the book this weekend. Thanks, Rowley~!

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