Spend 'Til the End: The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire [Hardcover]

Kotlikoff is a very interesting writer/economist. His previous book The Coming Generational Storm: What You Need to Know about America's Economic Future is a must read for anyone interested in the actuarial position of Social Security. Now, Kotlikoff and Burns focus on financial planning. To investigate it, Kotlikoff developed a sophisticated program (ESPlanner). Its underlying methodology is "consumption smoothing" that consists in evening out your discretionary income over your lifetime.

Per the authors, the financial service industry ignores consumption smoothing methodology for several reasons. First, it is really complicated. It includes many variables (mortgages, change in member of households, AMT, Social Security benefits taxation, etc...). Second, it reduces retirement savings needs. Third, it reduces the investment risk you need to incur to reach your goals. Thus, consumption smoothing would cut into the sales of financial products.

The authors spare no one in the financial service industry. The mutual fund managers don't earn their fees as 70% of them routinely fall behind the stock indexes. And, the 30% that beat the market change every year. Thus, the 30% who beat the market are just Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets. Hedge funds don't have a chance to make up for their high fee structure (1% management fee; 20% of returns). Insurance salesmen care more about their commission than your finances.

The authors are at their best when dealing with the intricacies of Social Security and Medicare. They explain unique strategies to maximize consumption smoothing such as Social Security double dipping. Similarly, you can come ahead by giving to a Charitable Gift Fund because it markedly reduces your taxes on Social Security benefits. They stress how rapidly Medicare premiums are rising and how we should boost savings even during retirement to withstand that fiscal shock.

Many of their other recommendations make good sense. Those include holding stocks in taxable accounts and bonds in tax advantaged ones (IRA, 401k) to lower your tax burden. They recommend using index funds instead of regular mutual funds to save on costs and boost returns. Diversify your 401k holdings away from your employer's common stock to reduce your own portfolio risk. They also suggest that marriage is a good deal from a tax standpoint in most cases. Their chapter on how to hedge against potential increase in taxes and inflation and upcoming cuts in Social Security benefits is very good. Their chapter on long term care is excellent.

But, some of their investment advice is less sound. Kotlikoff recommends inflation indexed Treasuries (TIPs) as a safe investment that is guaranteed to keep up with inflation (just as Robert Shiller did in Irrational Exuberance). But, on an after tax basis TIPs are unattractive. The yield they offer above inflation is really low (< 1.5% for 10 year TIPs). When inflation is higher than 3% you incur negative real returns after tax. This is because the entire return (inflation + yield) is fully taxable by the IRS. Also, TIPs with longer maturities offer little extra yield that does not compensate for the increase in interest rate risk. Thus, with TIPs it is questionable you can preserve capital let alone grow it. As a better alternative, I suggest medium term Munis.

Occasionally, they make errors. Upon retiring, Kotlikoff recommends converting your 401k into a Roth IRA because you may hit the 28% AMT that is lower than the 35% maximum tax rate. But, you don't "benefit" from the AMT because your tax liability is always the higher of the AMT or your regular taxes. Also, Kotlikoff suggests people's living standards go up when home prices fall because they save on insurance premium and property taxes. But, they don't. Insurance premiums are based on the replacement costs of the house. And, property taxes are based on assessed value. Replacement costs are always lower than the home market value. Assessed value almost always is lower too. Thus,in the majority of cases declining home prices will not save you money.

The authors make other questionable statements. Supposedly, on a consumption smoothing basis, a plumber maintains a higher living standard than a doctor. I don't believe that. Also a college education supposedly provides little financial benefits vs just high school. Meanwhile, figures from the US Census indicate that college grads make nearly twice as much as high school grads. I ran the numbers and calculated the NPV of a college education was several hundred thousand dollars. Also, they suggest that having a second child cost either little or is a cost saver. That's pretty hard to believe too.

Occasionally, the authors appear to contradict themselves. Late in the book, the authors share that per the Employee Benefit Research Institute 56% of retirees spend either the same or more than their pre-retirement level. This contradicts the authors' position that the financial service industry advocated replacement rate of 70% of pre-retirement earnings is too high. The mentioned survey instead suggests it may be too low.

In another chapter, the authors oversell the concept of annuitizing assets and reverse mortgages. That's where they push consumption smoothing too far. By annuitizing your assets and getting a reverse mortgage, you wipe out your estate leaving nothing for the next generation.

This financial planning book is a bit too erratic. To build a robust foundation, I recommend instead The Random Walk Guide To Investing.

A little background on myself before I start the review: I have read over 200 books on investing, so I count myself lucky if I learn 1 new thing for each new book I read. I have read quite a few columns by Scott Burns and generally agree with him on his ideas. I have read several papers and articles by Kotlikoff. I have not read any prior books written by either of these gentlemen. I have been a fan of index fund investing since 1990.

Before I read this book, I was also aware that Kotlikoff sells his own software package ESPlanner for $150 a copy plus $50 annual update fee ($200 for Monte Carlo version plus $50 annual update fee).

My first comment is that my perception is that Kotlikoff wrote the majority of this book. I base this upon the early writings of Kotlikoff and Burns that I have read.

I have long known that index funds usually beat roughly 70% of the actively managed funds in any given year......and my gut intuition is that similar statistics apply to the latest rage.....hedge funds. Kotlikoff points this out in a slightly different way saying that if 70% of mutual funds with the managers paid 1% of assets per year and 0% of the profits can't beat their appropriate index.......then there is no way a hedge fund charging 2% of assets per year and taking 20% of the profits will ever beat out index funds.

Kotlikoff also expresses the lack of financial literacy of Americans in a new way. I already knew that almost all Americans received no education in investing in our high school and college system. I used to get a kick out of the periodic investment tests that Money magazine used to give to average Americans..........and they consistently received grades of F on the test.

Kotlikoff asks how well Americans really know the subjects they are taught in our educational system, like geography. He points to surveys where these percentages of 18-24 year olds can not find these countries on a world map:

11%..............US
29%..............Pacific Ocean
58%..............Japan
69%..............England
85%..............Iraq

Kotlikoff says that if Americans don't really learn geography in an educational system designed to teach them geography.......then how will they ever learn basic investing skills.

Kotlikoff does devote quite a bit of time to behavioral finance.

Kotlikoff blasts the financial planning traditional rule-of-thumb that people should assume they will need about 80% of the income in retirement that they had their last working years. He argues that using the 80% rule causes too many people to save too much and some people to save too little. He criticizes the source of the 80% rule, the AON-Georgia State studies because they take survey income just prior to retirement, and then adjust it to retirement spending. He argues this methodology is not accurate enough and the financial products industry wants an 80% rule-of-thumb because they make more money based upon higher savings and investments.

Some pundits of Kotlikoff's idea the 80% rule-of-thumb is really the rule-of-dumb....argue that the 80% rule-of-thumb may be too low because future retiree health care costs are rising so much faster than inflation.

I have long advocated that some group should survey Americans just prior to and then during their retirement years. All of the financial data must be corroborated using financial statements since most Americans have no idea of their specific spending or investing lives. Such a study would be expensive........and maybe that is why it has never been done (to my knowledge).

I was a little surprised at Kotlikoff's statistic that 33% of homeowners get no federal tax break on their property tax and mortgage interest.......because these do not exceed the standard deduction limits.

Kotlikoff argues that everyone should pay off their mortgage. I completely disagree with this recommendation. For his financial analysis, Kotlikoff only uses bonds as the investment you would make if you did not pay off your mortgage. My calculations, and calculations done by many others......show that one is likely to earn 2 to 3% after-tax on the spread between the cost of the money (mortgage cost after tax) and the return of the money (60:40 portfolio in low cost index funds)after-tax. Once you get close to retirement, many people pay off their mortgage to give them peace of mind in retirement.........I have no argument with this if it gives you peace of mind.......but financially it is not the best decision.

Kotlikoff also presents the little known option of starting to withdraw Social Security, then later stopping the withdrawals........paying the government back......and then collecting higher payments for the rest of your life. From a behavioral finance point of view, I doubt many people would ever take this option. I also know of one case where this was done recently...........and it took an incredible amount of paperwork hassles to get it completed.

Kotlikoff also suggests using an income smoothing approach to get fairer divorce settlements. A few years ago I had personal experience helping a family member through a much contested divorce process. I was surprised to learn that the law does not require the use of net present value to fairly divide defined benefit pension plans. The law in Illinois only requires that the two parties reach an agreement which both parties think is equitable.......and the judge had to agree it is equitable. The customary practice in the courts of Central Illinois is to value pensions based upon the current cash out value of the pension........and not on the present value of the pension. In theory, I have no problem applying Kotlikoff's income smoothing approach to divorce........but in reality.....it will probably not be accepted in a contentious divorce battle.

Before reading this book, I was aware of using a charitable gift fund (e.g. from Vanguard) as an estate planning tool. I was not specifically aware that in many cases it gives the donor a higher lifetime net income after tax. I will be checking this concept out a little further through other sources.

I disagree with Kotlikoff's assertion that conventional financial planning recommends that your asset allocation to stocks versus bonds should change dramatically over time (e.g. using the Rule of 100). Bengen's work, the Trinity Study, and many others have shown retirees should hold at least 50% stocks in their portfolio to protect against inflation. Of course, if your portfolio is more than large enough to support your retirement living expenses, then you don't have a need to take as much risk and you could drop below the 50% stock allocation.

Kotlikoff argues that people's asset allocation should be adjusted about 4 times throughout their lives based upon changes in human capital and Social Security payments.

Another widely accepted rule-of-thumb that Kotlikoff blasts is the 4% safe withdrawal rate rule. It says that one should not withdraw more than 4% of your portfolio (with an annual inflation adjustment) to prevent outliving your money. The 4% rule is also based upon a 30 year retirement period and having at least 50% stocks in your portfolio (Bengen and Trinity Study).

Kotlikoff blasts the 4% SWR rule because it ignores pensions and Social Security. I completely disagree with this assertion. What idiot would ignore the retirement income from pensions and Social Security? Here is a typical application of the 4% SWR for a 64 year old couple who plan on retiring next year:

Current income........$100,000

Income Needed at Retirement......80% of $100K = $80K (this is 80% replacement rate rule)

Income from pension.......$40K

Income from SS............$28K

Income Shortfall.....$80K - $40K pension - $28K SS = $12K

The 4% SWR says you need a portfolio equal to 25X the amount of income you need to generate. So this couple needs a portfolio of 25 x $12K = $300K.

Kotlikoff also points out the well known phenomena that just because the historic return of stocks has been 10% per year.....you can not withdraw 10% of your portfolio each year. The reason is the sequence of returns may cause you to outlive your money. If the stock market has a Bear market during the first few years of your retirement, then your portfolio does not have time to recover to acceptable levels. William Bengen pointed this out back in 1994.

So if Kotlikoff's income smoothing approach is the best thing since sliced bread, then why has virtually none of the traditional financial planning industry accepted it? Why don't the Vanguard or Fidelity web sites offer an ESPlanner equivalent calculator? Kotlikoff would argue it is not accepted because if it was.......people would not save and invest as much........and the financial industry would lose profits.

I think there are several reasons his income smoothing approach has not been better accepted. One reason is there are already alterative financial planning software packages used by planners which give the same information (see May 2005 issue of Financial Advisor magazine story IS ESPLANNER+ BETTER? By Joel P. Bruckenstein)

Kotlikoff assets that traditional financial planning methodologies result in many people saving too much money and some people saving too little. With our US national savings rate now at 0%, do we really want to tell people they don't have to save as much for retirement? I also assume (I have never used ESPlanner) that ESPlanner requires some time by the user to enter more data than traditional web site planning calculators. With the US citizen's short attention span (witness 8 second sound bites on TV)......how many people will take more time to enter data into ESPlanner versus a quick Vanguard or Fidelity calculator?

Kotlikoff does correctly argue there are too many variables involved in retirement planning for the average person to consider. I would argue that Kotlikoff's ESPlanner might give a false sense of security to its users.......because there is no way to know future asset class returns, correlations between asset classes, inflation, tax policies, life spans, etc. It may be a better trade-off for people to quickly use a conventional web site calculator with a Monte Carlo analysis and get a general idea of their condition versus spending a lot of time on ESPlanner. I would also agree with Kotlikoff that the 80% replacement ratio is too general a rule-of-thumb.....it is probably close enough for people just starting their working careers.......but once you get within 5 years of retirement.....you should determine your real spending needs in retirement. You can use TurboTax to project exactly how much income you will need to have in retirement.....considering your pension, Social Security, and investment income.

Over-all, this book was readable. Time will tell if Kotlikoff's income smoothing approach will gain traction as a new tool in the financial planning toolbox.

In this age of full disclosure, it can be noted that I am the author and publisher of the book INDEX MUTUAL FUNDS: HOW TO SIMPLIFY YOUR LIFE AND BEAT THE PROS. This book is an introduction to the concept of index funds is and is sold on Amazon. I am also a contributing author to the book THE BOGLEHEADS GUIDE TO RETIREMENT PLANNING available from Amazon with an estimated release date of October 2009. I have also written 21 short stories on investing which are also available on Amazon.

If you want practical ideas on long term passive investing, read some of the books below:

The Richest Man in Babylon
Bogle on Mutual Funds: New Perspectives for the Intelligent Investor
The Millionaire Next Door
The Four Pillars of Investing: Lessons for Building a Winning Portfolio
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, Ninth Edition
The Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get On With Your Life
The Bogleheads' Guide to Investing

Overall a decent primer on how to think about personal finances from an economics point of view - with a caveat - much is controversial. I agree with the concept that your standard of living is the starting point to base financial decisions. It always has been, however the loss of pension programs for people to sustain their standard of living has changed how people need to think about funding that standard of living once they no longer work. This change has caught many in the baby boom generation off guard and hopefully younger generations will learn from this.

I also agree that a blanket income replacement ratio is nonsense for planning purposes and that individuals need to explicitly determine what their standard of living currently is and what level they wish to sustain when no longer working. The financial industry cuts the problem with a cleaver (with income replacement ratios) and then works with a scalpel on what is left (spreadsheets and calculators galore in office or online) as it relates to this point.

The use of index funds (Vanguard or Dimensional Fund Advisers from their website) to obtain asset class returns is another area of agreement. However, their asset allocation suggestions are very controversial.

Utilizing a mortality age ("maximum age of life") instead of longevity ("expected age of death") is also prudent advice given people are living longer; which means by definition that the expected age of death is getting older! In fact this being such an important point - I'm mystified that they don't explain how to determine maximum age of death (not really mystified, since you can buy their software which might tell you - not sure since the book is silent on what the software does) ... readers can go to the National Center for Health Statistics [...] and search "life tables" which will easily explain how to determine probability of living to a given mortality age based on your current age. A factoid for example: people ages 55 to 75 in U.S. have an approximate probability of 10-12% (range corresponds to age range) of living past age 95; and approximately 20-30% chance of living past age 90.

The above are just a few examples of agreed upon points in the book.

So the reader is aware, many planners and economists take issue with the author's assertions about many topics, and readers can follow the logic of many of their arguments and decide for themselves, if they are knowledgeable about the pros and cons of the debate, where they may agree or disagree with some philosophical differences. The reader should be aware that things are not as dogmatic as the authors may imply - and seem to give strength to their arguments by bashing the financial industry at almost monotonous frequency. Magically, the software and website touted in the book will perform complex calculations only they can provide. In other words, the book is a thinly veiled marketing piece for this software and website.

I came away fundamentally disappointed in the book in that it provided very little actionable points with most requiring their software to see just how their process may work. Also, subtle and at times, blatant use of fear are a turn off. Overall, a decent primer on how to think about money in many areas of personal finance; however major areas lacking are the need to buy their software to do the complicated calculations they claim need to be made to apply their concepts correctly; and, not balancing their discussion to point out what areas may be controversial and why. It would have been a better read had they included such discussion and dropped the monotonous sales pitch for their software.

Wealth Odyssey: The Essential Road Map For Your Financial Journey Where Is It You Are Really Trying To Go With Money?

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