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The Perils of Oversaving

Christine Benz

Christine Benz: Hi. I am Christine Benz from Morningstar.com. I'm here today with Larry Kotlikoff. Larry is the author of a new book called "Jimmy Stewart is Dead," and he is also the author of another book called "Spend 'til the End," which talks about spending and saving in and before retirement. Larry thanks for joining us.

Larry Kotlikoff: My pleasure.

Benz: Let's start with "Spend 'til the End" and talk about the concept there because it's a contrarian idea. You acknowledge that many people are very under-prepared for retirement but also say some people are over-saving for retirement.

Kotlikoff: Yeah and the title of this book that I wrote with Scott Burns who is a syndicated columnist... it has a double meaning here. You want to spend, but you want to spend until the end.

Benz: You don't want it to run out.

Kotlikoff: Yes. You have to plan to spend up to your maximum age of life, which could be 100. So we have in our country a lot of people that are undersaving I would say probably 40% of the population in is undersaving, but we also probably have 20% that are oversaving, because it is a very difficult calculation how much should you spend. Traditional financial planning asks you to set some target. They say that's your number. Set your number.

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Benz: How much you'll need to last you during retirement.

Kotlikoff: That's an extremely complicated problem.

Benz: Extremely.

Kotlikoff: Nobody could possibly do that on his own.

Benz: You have to predict your own longevity in a way, right?

Kotlikoff: Yeah, but even going beyond that, you have to think about all your tax payments every year from age 65 on. And you have to think about when you're going to pay your mortgage off.

Benz: Tax rates, which may change.

Kotlikoff: Right. It is beyond human capacity. It's like plotting your own trip to the moon when you have no physics background.

So what I have developed with my company is a software program called ESPlanner, Economic Security Planner. And we have a version that is free to the public on the web. It is at esplanner.com/basic.

It's a really cool program. You just go in there, it doesn't take very long; it's really simple to input your family information, your earnings, your assets, your basic information, and the program figures out how much you can spend on a sustainable basis, not just in retirement but starting right now.

Benz: Leading up to retirement.

Kotlikoff: Yes, and the idea is trying to get a smooth living standard per person. So it's figuring out how much discretionary spending per person you should be doing every year to have that level be smooth. The idea is that some of your spending is not discretionary and that is treated like negative income. You have to pay your mortgage, you have to pay for your college tuition for your kids if you want to do that.

It's really saying let's take the resources, let's figure out the nondiscretionary spending, what's left is the discretionary spending power and let's even that out so that we are not spending all our money on one day, which is not what we want.

We don't want to party today and starve tomorrow. And we don't want to do the opposite. We don't want to starve today and party tomorrow.

Traditional software tends to lead people to try and get them to starve today and party tomorrow because then the financial planner gets to manage more assets and charge more fees.

And then people are also induced to get into risker securities in order to make these targets that are far too high for a lot of people.

So we want to make it so targeting to save too much is not a very healthy thing either because A, you could lead yourself into investing in a more risky way that you want to, and secondly you may not survive. You may die at 65, right on the eve of spending this big pile that you spent your years accumulating. You may die.

So there is a risk in both ways. It's like yin and yang, and economics says you want to have a smooth ride.

The other cool thing about the software is that it allows you to safely raise your raise your living standard. Once you have a machine that can figure out your living standard, you can figure out how to raise it safely.

Benz: How does a deal with unknowables? So the threat of unforeseen medical expenses or something like that? How does it tell you to plan for those issues.

Kotlikoff: While the program runs in two seconds, so you can put in what-ifs. What if I have a special expenditure on medical. So you can certainly plan to have a special expense like a nursing home expense for seven years at a very high cost and put that into the program and see what your living standard looks like versus buying long-term care and paying the every year a special expense, which equals the premiums you have to pay every year.

So you can make comparisons of your living standard if you buy the long-term care policy versus you try and self-insure and see how you do.

You're absolutely right that all these uncertainties that we face such as how much our earnings will be in the future, it's very hard to fully deal with those in a comprehensive manner. So we are trying to keep it simple, but we allow people to enter assumptions and we caution people to make safe assumptions.

The middle name of our software is "security," so we are assuming a very low rate of return after inflation, and we're telling people take your current earnings and assume you can make the same thing in the future.

Benz: Right.

Kotlikoff: Not s higher pay.

Benz: Right. Well it sounds like an interesting program. It is ESplanner.com.

Kotlikoff: /basic.

Benz: /basic. So that's the free version. Thanks so much. Sounds like well worth checking out.

Kotlikoff: Thank you.

Benz: Thank you for joining us. I am Christine Benz from Morningstar.com.