Spend 'Til the End

The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire

Laurence J. Kotlikoff, Scott Burns

• Publisher: Simon & Schuster
• Year: 2008
• ISBN:
  9781416579670
• Topic: Développement personnel
• Subtopic: Finances personnelles

Rich or poor, young or old, high school or college grad, this book, written by economist Laurence J. Kotlikoff and syndicated financial columnist Scott Burns, can change your life for the better! If you follow the advice in this book, it will raise your living standard (possibly by a lot), improve your lifestyle, and help you spend 'til the end. And it will completely transform your financial thinking, turning every bit of conventional financial wisdom on its head. If this sounds like a revolution in financial planning, you got it. So do The New York Times, The Washington Post, The Wall Street Journal, USA Today, Time, Consumer Reports, and other top publications that have been featuring the authors' economics-based "consumption smoothing" approach to financial planning. Spend 'Til the End substitutes economic wisdom for the "rules of dumb" that currently pass for financial advice. In the process it indicts the investment and financial-planning industry for giving most people saving and insurance targets that are much too high and then convincing them to invest in risky mutual funds and expensive insurance policies. The result is that most people are scrimping and saving during the years when they could be spending and enjoying their money -- and with no sure payoff. Easy to read, this book is packed with practical and often shocking advice on whether to work, how to pick a career, which job to take, where to live, what sort of house to buy, how much to save, when to retire, which kind of retirement account to use, whether to have kids, whether to divorce, when to take Social Security, how fast to spend down your assets in retirement, and how to invest.

PART 1

Smooth Financial Paths

Whether we’re young or old, rich or poor, smart or cranially challenged, we all must decide how to lead a secure financial life without hoarding or squandering. Getting it right can be pretty tough.

Just ask George Foreman, two-time heavyweight boxing champion of the world and the oldest man ever to win the championship (at age forty-five!). In 1973, at the age of twenty-four, Foreman beat Joe Frazier for his first heavy weight title and had millions. By the mid-1980s he was broke.

As the fighter told the New York Times in 2006: “It was frightening, the most horrible thing that can happen to a man, as far as I am concerned…. I had a family, people to take care of—my wife, my children, my mother. I haven’t gotten over that yet…. It was that scary because you hear about people being homeless, and I was only fractions, fractions from being homeless.”

Foreman’s far from the only rich luminary to squander his/her riches. The list of famous spendthrifts includes Thomas Jefferson, Buffalo Bill Cody, Mark Twain, Ulysses S. Grant, Michael Jackson, Dorothy Hamill, Robert Maxwell, and Mike Tyson.

There are also extreme misers. Take Hetty Green. At the turn of the last century, Hetty was the wealthiest woman in America. Dubbed “the witch of Wall Street,” Hetty was notorious for her stinginess, never turning on the heat, never using hot water, and never changing her clothes. Her diet consisted of 15-cent pies. When her son, Ned, broke a leg and had to be hospitalized, she took him home because of the expense. As a result, poor Ned lost his leg to gangrene.

Obviously, Hetty was nuts. George Foreman was too, at least when he was blowing his wad. (He’s since rebuilt his wealth in part by selling the Lean Mean Grilling Machine.) You, we’re sure, are neither a spendthrift nor a miser. But given that you’re reading this book, you are probably worried whether you are saving the right amount, holding the right amount of insurance, and investing wisely.

You should be.

1. “I Am Financially Sick”

EVER OFFER AN AA member a drink? The first words out of his mouth are “I’m an alcoholic.” And a good thing too. Fessing up to having a drinking problem is tough stuff. But doing so has great curative powers. It eliminates the internal BS. It identifies the condition as medical. And it keeps the booze from flowing.

Owning up to financial disease is as curative. It makes us examine our financial decisions and seek financial advice.

So, please, repeat after us: “I am financially sick.”

You’re not alone. We’re all financially sick. We spend too much, save too little, underinsure, invest foolishly on hot tips, fail to diversify, try to beat the market, gamble, buy lottery tickets, shop compulsively, hold on to losers, max out our credit cards, get hooked on Starbucks, and spend as little time as humanly possible thinking about the future. Plenty of us end up living off Social Security.

Or we do the opposite. We pinch every penny, worry endlessly about our finances, oversave, buy too much insurance, take no risks, and avoid debt like the plague—only to wind up in a retirement home with far more money than we can possibly spend. We squander our youth instead of our money.

Either way, we screw things up. There is a good reason why. We each have two personalities at war within our brains: a current self and a future self. The future self is constantly yelling at the current self to behave, to be careful, and to worry about tomorrow. The current self is constantly telling the future self that life’s too short, that it’s party time, and that the future will take care of itself. Sometimes one wins, sometimes the other.

The struggle is continuous. Should we buy that Krispy Kreme donut? Should we eat out tonight? (MasterCard is always ready to give us a “priceless” experience.) Should we upgrade our cell phone? Can we afford a new car? Are we saving enough for the kids’ college? Wouldn’t a trip to Europe be fun? Should we contribute more to our 401(k)? Even the personal finance magazines are divided. The covers of Kiplinger’s, Money, and Smart Money yell at us to save, but inside they run articles telling us to spend.

To make matters worse, all manner of commercial enterprises are pitching their wares to our current and future selves. The sales effort is unrelenting. Buy this. Buy that. Save here. Insure with us. Invest now. Get in on the ground floor.

Conflicting advertising lures us simultaneously toward instant and deferred gratification. But the real trouble begins when our inner spender or inner saver always prevails—that’s when we start playing extreme games with our financial health.

Even those of us able to keep our spend now/spend later schizophrenia at bay can be financially sick. Financial health isn’t God-given, like good genes. It requires making the right spending, saving, and investment decisions, not once, not twice, but on an ongoing basis. Doing so is incredibly difficult. Sometimes we think we’re making the right financial moves, but we’re doing just the opposite. Or we can wait too long to move and miss golden opportunities.

Sounds hopeless, doesn’t it? It isn’t. Stick with us, and we’ll show you, in simple terms, what you need to do to improve both your present and your future. And we’ll explain how to use consumption smoothing to make lifestyle decisions that will raise your living standard.

Consumption smoothing means being able to spend ’til the end. Specifically, it means being able to sustain your family’s living standard over time, as you age, and across times, as you experience good ones and bad ones. Obviously you can spend only what you can afford. And what you can afford depends on your earnings, assets, pensions, Social Security benefits, taxes, and other economic resources, both positive and negative.

Trying to spend more than your economic resources permit spells trouble: bill collectors, a bad credit rating, and, ultimately, bankruptcy. But spending less is also a problem. Why work hard your whole life and die without spending what you’ve earned?

No one wants to splurge today and starve tomorrow—or starve today and splurge tomorrow. Instead most of us seek a smooth consumption ride—a stable living standard—throughout our lives. We want to live at the highest and safest level given our resources and tolerance for risk. Figuring out how is the true path to financial health. But doing so with just your brain isn’t easy—even for economists.

Clueless in Ann Arbor

Recently Larry attended a conference at the University of Michigan’s Retirement Research Center. The participants included fifteen of the world’s top economic experts on retirement saving. Their papers covered saving adequacy, health expenditures, retirement, and 401(k) contributions.

During one of the breaks, Larry gave the economists a quiz. He described a middle-aged, middle-class Ohio couple with an extremely simple set of demographic and economic characteristics, living in a world of perfect certainty—a world with no earnings, health expenditure, rate of return, inflation, tax, or Social Security surprises on the horizon.

Larry instructed each economist to write down on a piece of paper (“with no talking to your neighbor”) how much the household should spend in the current year as part of a plan to achieve a smooth (stable) living standard per person through time.

The correct answer was $87,549. The answers that came back ranged from $42,712 to $135,943, with an average value of $73,211. The closest response was off the mark by $12,872. Given the time allotted, the economists weren’t able to use calculators, computers, or equations. They were forced to make their spending decision with the same tool most people use for these matters: their brains.

The fact that every one of these expert brains preformed so miserably in such a simple setting speaks volumes for our ability to make highly complex financial decisions on our own. Evolution didn’t wire our brains to make sophisticated financial calculations. Our actual saving and insurance choices fall very wide of the computer-generated, economically optimal mark. Indeed, the statistical correlation between actual and economically appropriate financial decisions is close to zero. To put it bluntly, when it comes to dealing with our finances using just our brains, no one, including economists, has a clue!

2. Consumption Smoothing

A PICTURE TELLS a thousand words. So do examples. To understand consumption smoothing, please forget who you are, where you are, what you have, and what you want. Come with us on a trip—a drug trip.

Close your eyes. Now open them. Voilà! You’re a forty-year-old drug dealer. You’re single. You live in Chicago. You’ve got two kids living with an ex, whom you’ve totally abandoned. You have zero assets. But you’re not poor. You earn $100K a year—an excellent living—and the best part is, it’s tax free!

Your business is a bit unusual, but, hey, everyone’s gotta make a buck. You’re good at what you do. You consider yourself a professional. You follow the latest just-in-time inventory practices. You maintain quality control by sampling your wares. You wear a suit to work, which makes you feel good and reassures your upscale clients. And to bond with your customers, you read the financial press—the Wall Street Journal, Forbes, Business Week, Fortune, Barron’s, and all the rest—each of which hits you with endless ads about retirement planning.

These ads have done their job. You’ve decided to take retirement planning seriously. Indeed, after considerable reflection, you’ve arrived at a simple and serious strategy. Your plan is to retire on your sixtieth birthday and celebrate by mainlining a lethal dose of heroin. Yes, this is grim. But this is your plan, and we’re not going to argue with it.

How should you smooth your consumption between now and your termination date? Easy. Save nothing, and just spend $100K per year. Your living standard will be a perfectly stable $100K per year, year after year, right up to your going-away party.

Living Life to the Longest

Now suppose that you have a mind-altering (read chemical) experience. Suddenly you realize that life’s a bowl of cherries. Suddenly you want to live as long as possible. In your case that’s age ninety.

Your consumption-smoothing problem has gotten tougher. It’s now going to require some middle school math.

Let’s start by recalling that because you still want to retire at sixty, you have twenty years to work but up to fifty years to live. And though the chances are small, given your habits, that you’ll live to ninety, you have to plan for that possibility. The alternative is living that long and starving.

What to do? Well, your earnings over the next twenty years come to $2 million ($100K × 20). Dividing this amount by the fifty years you have left equals $40,000 per year—the amount you can spend each year without running out. (We’re assuming zero inflation and that you save money under your pillow to keep the government in the dark about your assets.)

Given your annual $100K earnings, this means you’ll have to save $60K per year before you retire. By age sixty, you’ll have saved $1.2 million, which will cover your annual $40K spending tab for your thirty years of retirement.

Note that your new passion—making it to age ninety—comes at a price: namely, a 60 percent reduction in your living standard for the next twenty years.

Finding Religion

Now suppose you have another “experience.” This time you find religion. Religion tells you that it’s time to grow up, get clean, and accept responsibility for your ten-and fifteen-year-old children. You agree, and within a week you find yourself feeding, clothing, and housing your two children, who are thrilled to be sharing your income.

How much should you spend, given that there are now two more mouths to feed? Good question. Here’s what you have to consider: The kids will live with you until they turn nineteen. The kids don’t eat as much. (Wrong!) Their clothes aren’t as expensive. (Wrong!) They don’t have your special pharmacological needs. (You hope!) And two can live more cheaply than one; in other words, the kids can share your apartment, television, heating, and so on. (Right!) So you need to factor in the relative costs of your kids as well as the economies of shared living.

But what’s your goal? Is it spending exactly the same total amount each year? Or is it having the same living standard per person now and in the future?

It’s the latter.

Consumpt...