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       Investor's Insight - Wednesday, April 5, 2006           
          "A Digest of Investment Opinion From the 
             World's Leading Financial Advisers"


Comment The Post Below...

by Scott Burns

Financial Planning 1.0 -- what most of us encounter through 
advisers or on the Internet -- meet Financial Planning 2.0. 
This eight-part series of columns, written by Laurence J. 
Kotlikoff and me, explores the consumption smoothing app-
roach to lifetime personal finance. While the idea has been 
developing for nearly a century, it has taken the power of 
today's personal computers to build the necessary tools. 
When we use these tools, we find that conventional planning 
is more likely to lead us astray than take us to financial 

Today's hottest personal finance book is Lee Eisenberg's 
"The Number." It's about the amount of money you need to 
retire. It's also, we're told, the path to self-knowledge, 
enlightenment and inner peace. Because once you know your 
needs, you can actualize them.

After contemplating our needs, we figured out our numbers. 
They're kind of big. We're talking roughly $200 million 
for Larry and $10 million for Scott. Why the difference? 
Well, Larry is rather needy. He needs the Lear jet, the 
big yacht, a private island in the Caribbean, lots of 
attendants, etc. Scott has more modest needs, mostly in-
volving a vintage trailer collection. 

One catch. Neither of us can save anywhere near enough 
money to hit our Numbers. Our needs, we realized, must 
fit within our budgets. Worse, the needier we are in re-
tirement, the less needy we can be before retirement.  

After lots of fussing about forgoing the jet and the 
trailers, we decided to set our retirement needs based 
on our current spending. This is what financial planners 
generally advise you to do -- set your retirement-
spending target based on your current spending. 


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But this didn't work either. Larry's current spending 
was far too high to maintain, and Scott's was ridicul-
ously low. What we really needed to figure out was the 
most we could safely spend on an ongoing basis. This 
consumption smoothing would balance our pre- and post-
retirement needs the way economics recommends.

Our "Eureka!" moment didn't last long. We next realized 
that determining our sustainable living standard is in-
credibly complicated, given all the interrelated factors, 
including future earnings, regular assets, retirement 
accounts, Social Security benefits, federal and state 
taxes, housing plans, estate plans and special expendi-

What to do? Well, Larry pulled out ESPlanner, the soft-
ware program he developed that figures out one's highest 
sustainable living standard in 10 seconds. It told him 
to start living within his means. It told Scott to start 
living it up. It also got us thinking about the wrong 
number -- about what happens when people set the wrong 
spending target for retirement as well as for survivors.

Retirement and widowhood can last a long time. So small 
targeting mistakes, since they're being made for so many 
years, can really screw up a financial plan. You could 
save far too much -- or far too little. You could buy 
silly amounts of life insurance. 

We checked this out using ESPlanner for a hypothetical 
40-year-old California couple, with two kids, a modest 
home, $125,000 in annual labor earnings, $75,000 in 
savings, a big mortgage and lots of future college ex-
penses. With the extra mouths to feed and the mortgage 
payments, the couple should save modestly -- only $1,440 
this year -- and do a ton of retirement saving as soon 
as they've got the kids through college. This plan main-
tains the couple's living standard through time. It's 
based on the right number.

But what if the couple set their number just 10 percent 
too high? In this case, they will be told by conventional 
financial software (which makes you set your own target,
rather than finding it for you) to save $11,955 a year.
And if the couple set their number just 10 percent too 
low, they will be told to save nothing at all. Clearly, 
saving recommendations are highly sensitive to the number.


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What about life insurance recommendations? The couple 
need to hold $600,000. But if they set their target just 
10 percent too high, they'll be told to hold $1,275,000. 
And if they set their target just 10 percent too low, 
they'll be told to hold only $100,000! 

Small mistakes in your number also mean large disruptions 
in your living standard at retirement, or if your spouse 
or partner dies. For our illustrative couple, targeting 
mistakes of 10 percent led to roughly 30 percent changes 
in living standard for retirees and survivors. This is 
consumption disruption, not consumption smoothing.

The really scary part is that a 10 percent targeting error 
is minor for conventional financial planning. For example, 
we consulted two of the best investment company Web sites, 
Fidelity and TIAA-CREF. Fidelity Investment's Retirement 
Quick Check calculator recommends a retirement spending 
target equal to 60 percent of annual earnings. For our 
stylized couple, this target is 36 percent too high. TIAA-
CREF's Retirement Goal Evaluator recommends a retirement 
spending target equal to 80 percent of annual earnings. 
For our stylized couple, this target is 78 percent too 

We think life's too short for target practice or wishful 
guessing. So read "The Number," think about the 
number, but be advised that any number chosen by you or 
by financial planners using horse-and-buggy tools is like-
ly to be dangerously wrong. 


Laurence J. Kotlikoff's Web page:

ESPlanner software Web page:

"The Coming Generational Storm" (at MIT Press): 

"The Coming Generational Storm" (at Amazon.com): 

(Questions about personal finance and investments may be 
sent to Scott Burns, The Dallas Morning News, P.O. Box 
655237, Dallas, TX 75265; or by fax: (214) 977-8776; or 
by e-mail: scott@scottburns.com. 
Check the Web site: www.scottburns.com. 
Questions of general interest will be answered in future 

(Investor's Insight reflects the opinions of experts. It does 
not recommend any specific investments, and no endorsement is 
implied or should be inferred. For more information, contact 
the individual firms cited).



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