Book Notes: Spend ‘Til The End, Part I

As mentioned previously, some notes from Spend ’til The End.

Part I: Smooth Financial Plans

There are three parts to an economics-based approach to financial planning:

1 – Maximizing your spending power. Making financial choices that provide you with more money to spend for the same effort. For instance, whether to collect a smaller Social Security benefit at age 62, or a larger benefit later. Making the right choice doesn’t take any more time or effort than the wrong one, but the consequences on your living standard can be huge. Same for jobs, mortgages, etc.

2 – Smoothing your standard of living. Economists call the spreading of your spending power over time “consumption smoothing.” It ensures you have spending power in good and bad times, and enables you to spend ’til the end. It doesn’t mean starving now to feast later – or vice versa. It means being able to sustain your family’s living standard over time, as you age, no matter what.

3 – Price your love. No, not on Craigslist. This refers to knowing what it costs in terms of your living standard to do the things you love. For instance, taking a wonderful but low-paying job.

The authors believe we are all financially sick. (Literally. Chapter 1: “I Am Financially Sick.”) We spend too little, save too much, take too many risks, take no risks, gamble, shop compulsively, buy lottery tickets, under-insure, hold the wrong stocks, make spontaneous buys, fail to diversify, max out our credit cards, take on too much debt or drown in it. And that’s just on Monday.

But consumers aren’t fundamentally irresponsible. There’s a ton of bad advice out there, much of it coming from institutions who make money by selling financial products. Common rules of thumb like “save 15% of your income” are woefully lacking. Most institutions’ online calculators are biased towards oversaving, since those institutions make more money by selling “riskier” products to make up for a lack of savings.

Consumption smoothing should be the goal – an even, sustainable living standard throughout your life. Financial planning as practiced on Wall Street, though, leads to consumption disruption. Small mistakes in initial assumptions often become huge mistakes in how much you’re told to save and how much life insurance you buy. Because the probability of making planning mistakes is quite high, conventional advice often transforms oversavers into undersavers and vice versa. To the authors, financial planning is often just a marketing tool.

Chapter 4 was called “Pimping Risk.” For some reason I found this hilarious. Also, Wall Street is not your friend.

Eleven tips to maximize and protect your standard of living.

1 – Setting spending targets is asking for trouble.
Small initial errors can cause huge downstream mistakes.

2 – Typical households should hold relatively more stock than the rich. Low and middle income groups have fewer financial assets as a percentage of income. In addition, their living standard is reasonably safe due to labor earnings and government benefits. They therefore stand a lower chance of suffering a drop in living standards compared to a family living exclusively off investments.

3 – Diversifying your portfolio is generally a bad idea.
In the margin here I wrote “buy these guys a beer.” As the authors point out, a majority of our economic resources are already tied up in bond-like resources such as social security, retirement benefits or other nonfinancial assets. In that light, diversification would actually mean concentrating financial assets in stocks.

4 – Stock holdings should rise, fall, rise and fall with age. Take that, life cycle funds! The amount of stock you hold should reflect your commitments and capacities throughout life. The authors recommend having just a bit in stocks when very young, considerably increasing your allocation to stocks in middle age, reducing your holdings as retirement approaches, increasing it again in early retirement and then, finally, reducing it again in late retirement – assuming you can remember. I’ll be happy if I’m still wearing pants then.

5 – Having children may lower your need for life insurance. No, not because kids drain the life out of you. (Just kidding, guys!) In the economic sense, the more kids you have, the more you lower your living standard. So, you can reduce the protection level required because there is a lower standard to maintain. Children also come along with their own life insurance polices on their parents’ lives, such as social security children’s survivor benefits. Only an economist can get away with this argument, by the way.

6 – Spouses or partners with the highest earnings may need the least life insurance. If your spouse is younger than you or expects to retire later, that spouse may have more lifetime earnings to protect than you.

7 – The rich have bigger saving and insurance problems than others. Because of its progressive benefit formula, Social Security retirement and survivor benefits replace a much larger fraction of the earnings of most workers than the rich.

8 – Maximizing retirement account contributions is generally undesirable. The majority of young and middle age households are cash-constrained due to mortgages and home/auto loans bundled with other off-the-top expenses. When such households maximize retirement contributions, it often translates into a cut in current living standards…leading to a higher living standard in old age. Again, the idea is to smooth that consumption.

9 – Waiting to take Social Security can dramatically raise your living standard. If you wait just an extra year to collect benefits, they are permanently increased by approximately 8% (over and above inflation) due to compounding.

10 – Oversaving and overinsuring are very risky. Oversaving will result in a cut in your present living standards, and should you meet your demise as soon as you reach retirement, it will have all been for naught. When you overinsure, you risk living too long and never benefiting from the insurance money, despite cutting your current living standard to pay those premiums.

11 – Mortgages offer no tax advantages for most households. A majority of low and middle income households are unable to deduct mortgage interest since they don’t itemize their deductions. Itemizing is not very beneficial even for those who do it as there is no real tax advantage of having a mortgage. That logic is explained via an example: Assume you can pay off your mortgage but don’t and instead invest in bonds. The interest you earn from bonds is lower than the mortgage interest, and interest received on bonds is also taxable. So, the vast majority of people would better off by paying off the mortgage.

We’ll pick it up from there next Thursday.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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One Response to Book Notes: Spend ‘Til The End, Part I

  1. Kirk Kinder says:

    I have read quite a bit of Scott Burns work when he wrote for a newspaper in Dallas and was syndicated nationwide. I thought he was pretty solid. But, I find myself disagreeing with most of what you summarized here. I didn’t read the book so I am basing my points off your summation so I could be misconstruing their work, but…

    1. You have to have spending targets. No one knows what we will spend from year to year, but if you don’t have a general goal or benchmark, you could end up in real trouble. Budgeting is important even in retirement. However, things could come up that you didn’t expect such as medical expenses, spoiling a new grandkid, or taking up gambling.

    2. Holding stock based on any socio-economic idea is pure dreaming. You need to focus on your risk tolerance. If you can’t handle losses then you shouldn’t load up on equities. Period. The reason is if you do this, then after a year like 2008, you may abandon them completely, which is just as foolish as overloading on them to begin with. Also, the rich are usually rich because they are the risk takers in our nation. I know several wealthy folks who could just roll jumbo CDs their entire life and still die with more money than I will ever have. Yet, they want aggressive portfolios cause they like and thrive on the risk. Hopefully, they will find the Tarpon fund.
    3. I would agree with this point if it was 1950, but we have a social security net with lots of frays and bigger holes, the retirement pension is a thing of the past, and non-financial assets (probably meaning homes) are not the cash machine people thought. We are on our own. Manage your assets wisely. I believe diversification is a wise move.
    4. Need to see more about their reasoning on this. But, I do think lifecycle funds suck. And, I have never bought into the 20 somethings being all stock. Focus on risk tolerance even at a young age. I know some 20 year olds who have already sworn off stocks due to the downturn. Big mistake. Of course, they will probably get back into stocks in a few years after the market has turned up. Just in time for the next drop.
    5. These guys must not have kids. My living standard may drop as I go back to drinking cheap beer so I can buy diapers, but my total cost goes up. And, social security doesn’t pay as much as you might think. There is a family maximum so a family with 20 kids won’t get more than a family with 2 kids (or once the max is reached). Hear that Octomom.
    6. Life insurance is a tool to replace necessary income in case of death. The key is necessary. The younger spouses income might be so low it doesn’t really have an impact if it were gone. So no need to insure it at all. So this is an individual item, not a rule of thumb issue.
    7. Not sure what their point is here.
    8. Balderdash. Hogwash. Gobedlygook. These words describe this advice as well as comments I received from professors in college. Savings catch up is tough. Better to do it when young so you get that compounding thing going. Plus, most young people, before kids, have expenses like beer, electronics, and beer. Did I mention beer? So the lifestyle is simple. Save while you can. Once the kids come, you are lucky if you can rub two nickels together. When young, you actually play quarters.
    9. I go against the grain here. The numbers show that waiting pays off. No questions. However, this is one area that it is a total crap shoot. If you die at 64, you never get a dime despite putting 12.4% of your income in the fund (remember your employer pays half that would otherwise go to you). It may be considered a fixed income, but it is risky in that you are playing Russian roulette. Die early and you lose. If you can take it early and let your investments grow, you may be better off, especially if you die cause your heirs get more. Plus, the gubment isn’t doing a good job of managing social security. So I go against the grain here.
    10. If you don’t save, you risk living in poverty during retirement. I choose to risk dying with money than living in retirement without. Agree over-insuring is a waste of money. Buy the minimum insurance that you need and no more.
    11. Agree.