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In December, able2pay.com will have a fresh analysis of value and volatility in the stock and bond markets. This post is a preview of the topics to be covered. Always timely, questions like these seem particularly germane now. Stocks are over-valued by many of the traditional metrics; interest rates on bonds imply dismal future returns; and cash has languished below inflation rates for a painfully long period. If no investment has obvious value, does something have to give, and if it does, is there any prudent shelter from the ensuing volatility?
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Accurately measuring whether stocks are over- or under-valued is hard enough. Yet even if that problem were solved, others would remain. An indicator that predicts a big change in stock prices over the near term is likely to have a wild margin of error. Longer term, the error-rate may decline, leading to a safer, more confident prediction, but the price-change will also fade to a smaller size. Is there any way to have it all: calculate a credible benefit, capture it safely, and bank it soon? |
Are you investing for the near-term or the long-term? Do you have some immediate financial goals, perhaps supporting a child who's in college, plus some future objectives, including your own retirement? A new article helps you adapt your investment portfolio to match the various time-horizons of your goals. It offers specific examples and links them to our Best-Invest calculator. The full article, How Long?, is on the Portfolios menu. |
The best and most popular news-posts at able2pay.com are being updated and moved. To see what's available, click on Retirement or on the Goals, Investing, or Portfolios menus at the top of this page. Included under Portfolios is an article on Basic Portfolios that amplifies the post immediately below.

Do you want guidance on funds to buy in your 401(k), 403(b) or IRA, college-savings, or investment account? Here's an easy method from able2pay.com.
Step 1. Set a target percentage for stock funds.
When do you expect to spend most or all of the investments in this account?
Step 2. Allocate to suitable stock and bond funds.
Use your target to find the matching row in the table below. Then use the percentages in your row to invest in the funds shown by the column headings. Most 401(k), 403(b), IRA, college-savings, and investment accounts will offer these funds or equivalents. Below the table are descriptions that will help you find the right ones for your account.
- Answer two questions to set targets for stocks and bonds, suitable for your goals and preferences.
- Allocate to three basic funds, which any firm will offer.
Step 1. Set a target percentage for stock funds.
When do you expect to spend most or all of the investments in this account?
- All in the next year or two: Set final target = 0% and stop (skip the next question).
- Most or all within five years: Set preliminary target = 30% and continue.
- Six or more years from now: Set preliminary target = 60% and continue.
- Maximize gains: Add 15% to your target.
- Minimize losses: Subtract 15% from your target.
- Do both: Keep your preliminary target (no change).
Step 2. Allocate to suitable stock and bond funds.
Use your target to find the matching row in the table below. Then use the percentages in your row to invest in the funds shown by the column headings. Most 401(k), 403(b), IRA, college-savings, and investment accounts will offer these funds or equivalents. Below the table are descriptions that will help you find the right ones for your account.
Target | US Stocks | International Stocks | Intermediate Bonds | Short-Term Bonds |
---|---|---|---|---|
75 % | 50 % | 25 % | 25 % | 0 % |
60 % | 40 % | 20 % | 40 % | 0 % |
45 % | 30 % | 15 % | 55 % | 0 % |
30 % | 30 % | 0 % | 40 % | 30 % |
15 % | 15 % | 0 % | 25 % | 60 % |
0 % | 0 % | 0 % | 0 % | 100 % |
- U.S. Stocks: Use an index fund that invests in the total U.S. stock market. If not available, use an index fund of large-cap U.S. stocks or the S&P 500. Avoid anything that's not indexed or that's more specific.
- International Stocks: Use an index fund that invests in all non-U.S. stock markets. If not available, use an index fund of EAFE stocks (developed countries outside the U.S.). Avoid anything that's not indexed or that's more specific.
- Intermediate Bonds: Use a bond fund that invests primarily in a broad mix of U.S. treasury and corporate bonds. Avoid funds with a limited focus on TIPS or on inflation-linked, international, high-yield, or short-term bonds. In a 401(k), 403(b), or IRA account, you should also avoid municipal bonds.
- Short-Term Bonds: Use a fund of U.S. treasury bonds with maturities less than five years. If not available, use instead a short-term bond index fund or a money-market fund.
Optional Step for IRA and Taxable Accounts
The following options are good improvements for an IRA or taxable account, but are unlikely to be available for your 401(k), 403(b), or college-savings plan:
- Invest at Betterment, and simply use the target from Step 1. Betterment's automated service will invest in a well-designed set of U.S. and international stocks and bonds.
- Invest at Vanguard, using the alternate table below and these funds: Global Minimum Volatility; either Mid-Cap Value Index or Strategic Equity; Intermediate-Term Bond Index; and Short-Term Treasury.
- Invest in a low-fee brokerage account such as Fidelity or TD Ameritrade, using the alternate table below and these Exchange-Traded Funds (ETFs): iShares MSCI All-Country World Minimum Volatility (ACWV), Vanguard Mid-Cap Value (VOE) or equivalent; Vanguard Intermediate-Term Bond (BIV) or equivalent; Vanguard Short-Term Government Bond (VGSH) or equivalent.
Target | Global Low Volatility | Mid & Small Value | Intermediate Bonds | Short-Term Treasury |
---|---|---|---|---|
75 % | 50 % | 25 % | 25 % | 0 % |
60 % | 40 % | 20 % | 40 % | 0 % |
45 % | 30 % | 15 % | 55 % | 0 % |
30 % | 30 % | 0 % | 40 % | 30 % |
15 % | 15 % | 0 % | 25 % | 60 % |
0 % | 0 % | 0 % | 0 % | 100 % |
Part of a series on retirement, this post explains how to use our calculator, Retiree Reserves. For other articles in the series, visit the Retirement tab.
FAQs
Who should use the Retiree Reserves calculator? It is mainly intended for people who are retired or expect to retire in a year or two. However, you may also find it helpful if you are in your late 50's or early 60's and are considering whether to buy long-term care insurance.
What does the calculator do? It generates average and high-end estimates of the dollar value to hold on reserve for potential future expenses during retirement. These are potentially large expenses not included in your normal budget. In addition, the calculator recommends how to invest your reserve funds. All the calculator's estimates and recommendations take into account the life expectancy for your age and gender.
What potential expenses will the calculator estimate? Three types of expenses are covered: health care other than insurance premiums, long-term care services, and unusual housing expenses such as major home repairs.
How does the calculator estimate these unknowable costs? It uses data from various public sources on your expected longevity; on the expenditures of people over 65 years of age for medical costs, long-term care services, and household maintenance; and on home prices. If you own a home, condo, or coop, the calculator uses your home's value as input for the estimates. Optionally, the calculator allows you to personalize some inputs, such as long-term care in your area, if you wish.
What if you rent your home or apartment? In that case, the calculator will omit housing maintenance from your estimated reserve fund, since rent is part of your normal budget.
How does the calculator handle long-term care? The average estimate is based on government data regarding the amount actually paid for long-term care by people age 65 and older. The high-end estimate assumes two years of a private room in a nursing home, at rates based on a recent, nationwide survey (or a rate you specify).
What does the calculator do? It generates average and high-end estimates of the dollar value to hold on reserve for potential future expenses during retirement. These are potentially large expenses not included in your normal budget. In addition, the calculator recommends how to invest your reserve funds. All the calculator's estimates and recommendations take into account the life expectancy for your age and gender.
What potential expenses will the calculator estimate? Three types of expenses are covered: health care other than insurance premiums, long-term care services, and unusual housing expenses such as major home repairs.
How does the calculator estimate these unknowable costs? It uses data from various public sources on your expected longevity; on the expenditures of people over 65 years of age for medical costs, long-term care services, and household maintenance; and on home prices. If you own a home, condo, or coop, the calculator uses your home's value as input for the estimates. Optionally, the calculator allows you to personalize some inputs, such as long-term care in your area, if you wish.
What if you rent your home or apartment? In that case, the calculator will omit housing maintenance from your estimated reserve fund, since rent is part of your normal budget.
How does the calculator handle long-term care? The average estimate is based on government data regarding the amount actually paid for long-term care by people age 65 and older. The high-end estimate assumes two years of a private room in a nursing home, at rates based on a recent, nationwide survey (or a rate you specify).
Tips
- You can force the calculator to omit uninsured medical costs from the estimates by entering 0 in question 3, which asks about such costs. This will eliminate them from the high-end estimate.
- Similarly, you can force the calculator to omit long-term care from the high-end estimate by entering 0 in question 4, which asks about your preferred expense-level for long-term care.
- If you own a home, condo, or coop, but want to exclude major housing expenses from the estimate, answer "No" to question 6, which asks whether you are an owner or renter.
- Try running the calculator with different inputs, to see how your need for reserve funds would be impacted.
This post was part of a series which is now located on the Retirement tab. The series covers:
- The finances of Rachel, a hypothetical retiree, and the decisions she had to make.
- Key goals for any retiree.
- How to estimate a retirement budget.
- Home equity as a retirement asset.
- A reserve fund during retirement, mostly for medical expenses.
- Annuities that do (or don't) make sense for retirees.
- Managing income and payouts from your retirement savings.
Why a Reserve Fund?
Some economists argue that during retirement, you should be "dis-saving," by which they mean spending down your assets, not holding reserves or saving for the future. They might also argue that "mental accounting" is irrational. From the standpoint of objective financial analysis, they would say your decisions can go awry if you mentally set aside certain funds to be spent only for certain purposes. Money is fungible, they point out. It can be used for any purpose, so spend it where you need to, constrained only by a goal to maintain a stable standard of living.
While in principle one might agree with these notions, in practice most of us do otherwise. We feel safer if something is set aside to cover the unexpected. Whether it's called a reserve fund, an emergency fund, or a sheltered account, it's a safety cushion whose purpose is as much psychological (for peace of mind) as financial (for budget planning).
Because the fund's objective is to pay for the unexpected, it is really a form of self-insurance. During your working years, a reserve fund mainly offers protection against losing your job. Thus, it's unemployment insurance that you devise for yourself and your family. During retirement, the main risk of unplanned expenses is for health care not covered by Medicare or other insurance. To a lesser extent, there may also be risks of occasional large expenses for a home you own, if not covered by your home-owner's insurance.
To plan a reserve fund for your retirement, ask yourself three questions:
While in principle one might agree with these notions, in practice most of us do otherwise. We feel safer if something is set aside to cover the unexpected. Whether it's called a reserve fund, an emergency fund, or a sheltered account, it's a safety cushion whose purpose is as much psychological (for peace of mind) as financial (for budget planning).
Because the fund's objective is to pay for the unexpected, it is really a form of self-insurance. During your working years, a reserve fund mainly offers protection against losing your job. Thus, it's unemployment insurance that you devise for yourself and your family. During retirement, the main risk of unplanned expenses is for health care not covered by Medicare or other insurance. To a lesser extent, there may also be risks of occasional large expenses for a home you own, if not covered by your home-owner's insurance.
To plan a reserve fund for your retirement, ask yourself three questions:
- What potential expenses should you self-insure with a reserve fund?
- What amount should you reserve to cover those expenses for your unique circumstances?
- Where should you hold and invest your reserve fund?
This post is the second of three on inflation during retirement:
- Cost of living adjustment (COLA). Analysis of the 0% COLA for Social Security in 2015.
- Better ways to measure what this year's inflation really was (this post).
- Predicting inflation next year, to better forecast your budget.
Some History
The Social Security Administration (SSA) began making annual cost-of-living adjustments (COLA) in 1975. They compute the COLA value in the early fall from three recent months of data on the Consumer Price Index (CPI).
Should those three months happen to witness a large but temporary gain or drop in consumer prices, the SSA COLA would affect payments for a full year, starting in January, as if the temporary event had been long-lasting. In 1986, for example, the prices of oil and gas were plunging when the COLA was computed. In 1987, although energy prices stabilized and inflation quickly returned to its previous level, retirees were stuck for the full year with SSA benefits set at a lower level because of the earlier, temporary downdraft. Of course, it can work the other way, too. A temporary uptick in the CPI when the COLA is computed can give retirees a nice benefits for 12 sweet months the next year.
There are better alternatives. But they are not the ones most often cited by commentators, which were covered in the first post in this series. Have a look at the chart below. It shows the SSA COLAs since 1975 (green dots), the full CPI-U index (blue line), and two alternatives for computing COLAs.*
Should those three months happen to witness a large but temporary gain or drop in consumer prices, the SSA COLA would affect payments for a full year, starting in January, as if the temporary event had been long-lasting. In 1986, for example, the prices of oil and gas were plunging when the COLA was computed. In 1987, although energy prices stabilized and inflation quickly returned to its previous level, retirees were stuck for the full year with SSA benefits set at a lower level because of the earlier, temporary downdraft. Of course, it can work the other way, too. A temporary uptick in the CPI when the COLA is computed can give retirees a nice benefits for 12 sweet months the next year.
There are better alternatives. But they are not the ones most often cited by commentators, which were covered in the first post in this series. Have a look at the chart below. It shows the SSA COLAs since 1975 (green dots), the full CPI-U index (blue line), and two alternatives for computing COLAs.*
Before considering the alternatives, compare the SSA COLA to the actual CPI-U. In 1980 and 2006, the SSA COLA was well above the CPI-U level, giving a nice boost to retiree's budgets the following year. In 1986 and 2010, both the SSA COLA and the CPI-U were low, but the CPI-U bounced back the following year to a normal level of inflation. Yet retirees had to budget for the previous year's low COLA of 1% or less.
Two Alternatives
The SSA COLA and CPI-U both vary from year-to-year to a visibly greater extent than the two alternatives, shown by the yellow and red lines on the chart. What are these alternatives, and what makes them different?
- Core is a measure that's been computed for decades as an alternative to the full CPI-U. It uses the same data, but leaves out Food and Energy. If domestic gas, home heating oil, or imported food should rise of fall temporarily, the full CPI-U will follow along, but the "core" inflation index won't. Wait a minute! Don't retirees have gas stoves, drive cars or take buses that use gasoline, and buy foods that may have volatile prices? Of course they do. That's why the CPI-E index ("E" is for "elderly") includes Food and Energy, in portions calibrated to the spending habits of older households. But because it includes them, the CPI-E has the same flaw evident in the chart for the SSA COLA. Any index the includes Energy is prone to the boom-and-bust cycle of the gas and oil business. Possibly, some Foods have the same failing, especially if they are imported and subject to foreign currency rates. Omitting Food and Energy from an inflation index simply removes troublesome volatility.
- Trimmed is another measure derived from the CPI-U. Like the Core index, it omits certain items from the calculation. Of the 40-plus items in the CPI-U, the "trimmed" index omits the 3 or 4 that showed the highest inflation in a given month, and the 3 or 4 that had the lowest inflation. If gasoline prices surged or collapsed in a given month, they are omitted. The same goes for utility bills or medical services or food away from home or any other component of CPI-U. The method is agnostic, however, about what to drop. Unlike the core inflation index, which always drops the same items, the trimmed index zeroes in on the current offenders, whatever they may be.
Some Evidence
To see how the core and trimmed indexes are better, consider the statistics in the chart below. It shows that over the 33 years since 1983, when both indexes were available, they had long-run averages similar to those of CPI-U and SSA COLA. Thus, neither the core index nor the trimmed index would have given a retiree more or less over the long run, than would have been generated by the full CPI-U or the standard SSA COLA. If the trimmed or core index gave more in a particular year, they tended to give correspondingly less in another year. The compound rate of the core index was virtually identical to the SSA COLA, while the trimmed index was about 0.1% higher. The median or middle rate over the 33-year span was virtually the same for the trimmed rate as for the SSA COLA.
Look next at the standard deviation, a measure of volatility. The trimmed and core indexes had less volatility than the SSA COLA and the CPI-U. This is statistical evidence of the pattern visible in the historical chart, where the path over time was smoother for the trimmed and core indexes.
The smoothness of the two alternative measures is important for another reason. It makes the trend of cost-of-living adjustments more predictable for retirees. This year's COLA is more like next year's inflation. In the historical chart, the 0% SSA COLAs in 2009, 2010, and 2015 would have been small but non-zero values, had the trimmed or core index been used. Conversely, the spike to nearly 6% for the SSA COLA in 2008 would have been a more normal value between 2% and 4% with the other two indexes.
The smoothness of the two alternative measures is important for another reason. It makes the trend of cost-of-living adjustments more predictable for retirees. This year's COLA is more like next year's inflation. In the historical chart, the 0% SSA COLAs in 2009, 2010, and 2015 would have been small but non-zero values, had the trimmed or core index been used. Conversely, the spike to nearly 6% for the SSA COLA in 2008 would have been a more normal value between 2% and 4% with the other two indexes.
The final chart, shown above, provides statistical evidence that the two indexes were more predictable. Both the CPI-U and SSA COLA were utterly unable to predict next year's inflation. Their correlation was virtually zero, both with their own value in the following year, and with the future value of the full CPI-U. In contrast, the core and trimmed indexes in a given year were highly correlated with their own value the following year (r > 0.7). They were even somewhat correlated with next year's CPI-U (r > 0.3).
What Really Matters
As noted in the first post in this series, it doesn't help retirees to ask SSA to compute an index that simply weights all the normal components differently, whether in a way that matches the spending patterns of older individuals (CPI-E) or by a method that focuses on supposedly necessary but volatile expenses. What really matters to retirees is to have a method that offers reassurance on questions like these:
- Will I be able to live within my budget next year?
- Will my COLA this year be like it was last year?
- Over my retirement years, will my SSA benefits truly keep up with inflation?
* For CPI-U and Core inflation, the plotted value is a compounded annual rate of change. First, for a given month, the non-seasonally-adjusted value is divided by the same value a year ago. This value is then compounded for the months of July, August, and September, to approximate the three-month method used for SSA COLA. For Trimmed inflation, the plotted value is compounded in September over the preceding 12-month period, using the seasonally adjusted monthly values of the 16% Trimmed Mean CPI as calculated by the Federal Reserve Bank of Cleveland. In effect, all three measures are doubly smoothed. The CPI-U and Core measures first smooth out seasonal effects by comparing the non-adjusted, current month to a year ago, then smooth again by compounding over three months. The Trimmed value first smooths out seasonality by averaging the seasonal adjustments on each expense category within a given month, then smooths over the full year by compounding 12 months of rates. Although the methods are somewhat different, the Core and Trimmed values end up having very similar volatility.
Data sources: FRED for CPI-U, Core CPI-U Less Food and Energy, and 16% Trimmed Mean CPI. Social Security Administration for its annual COLA values.
This post was part of a series which is now located on the Retirement tab. The series covers:
- The finances of Rachel, a hypothetical retiree, and the decisions she had to make.
- Key goals for any retiree.
- How to estimate a retirement budget.
- Home equity as a retirement asset.
- A reserve fund during retirement, mostly for medical expenses.
- Annuities that do (or don't) make sense for retirees.
- Managing income and payouts from your retirement savings.
Housing for Retirees
Housing is the single largest expense for retirees. According to the U.S. Labor Department's 2014 survey of consumer expenditures, housing is 34% of all expenses for households whose "reference person" is 65 years of age or older. That's more than double the portions for the next-highest categories of food, transportation, and medical care. They each account for 12% to 16%.
Of the 34% spent on housing for those over 65, the biggest share (18.5%) goes to the cost of shelter, which includes mortgages, rent, repairs, maintenance, and property taxes. Next come utilities (8.6%), including electricity, gas, telephone, water, and heating oil. Other expenses, such household furnishings, upkeep, supplies, and services, are the smallest portion (5.8%).
Is renting or owning better for a retiree? What about a reverse mortgage, or using home equity as a reserve fund, or leaving your home as an inheritance? For more on these matters, click here to go to the full article.
Of the 34% spent on housing for those over 65, the biggest share (18.5%) goes to the cost of shelter, which includes mortgages, rent, repairs, maintenance, and property taxes. Next come utilities (8.6%), including electricity, gas, telephone, water, and heating oil. Other expenses, such household furnishings, upkeep, supplies, and services, are the smallest portion (5.8%).
Is renting or owning better for a retiree? What about a reverse mortgage, or using home equity as a reserve fund, or leaving your home as an inheritance? For more on these matters, click here to go to the full article.
This post was part of a series which is now located on the Retirement tab. The series covers:
- The finances of Rachel, a hypothetical retiree, and the decisions she had to make.
- Key goals for any retiree.
- How to estimate a retirement budget.
- Home equity as a retirement asset.
- A reserve fund during retirement, mostly for medical expenses.
- Annuities that do (or don't) make sense for retirees.
- Managing income and payouts from your retirement savings.
Decision Time
As a recent retiree and a new widow, Rachel had lots of questions. She wasn't expecting her brother Billy to be much help. To be sure, he would have some advice. How much she could trust his self-professed expertise was another matter. Realizing the decisions were going to be hers in the end, Rachel had done her own homework before seeking a second opinion from Mr. Over-Confidence.
"Billy, I think I have to change something."
"Yeah, I knew that. Let me tell you about what I've done with my IRA."
"It's not your IRA I'm worried about," said Rachel, suspecting that Billy's retirement plans might actually benefit from oversight by someone other than himself. But she wasn't going to go there, not today.
"I've got too much cash in my bank account," Rachel continued. "There's the $100,000 payout from Isaac's life insurance, plus the $20,000 we had saved ... " Her voice trailed off as she remembered how they had planned to spend their golden years, before the accident swept Isaac out of her life forever ...
Click here to read Rachel's full story.
"Billy, I think I have to change something."
"Yeah, I knew that. Let me tell you about what I've done with my IRA."
"It's not your IRA I'm worried about," said Rachel, suspecting that Billy's retirement plans might actually benefit from oversight by someone other than himself. But she wasn't going to go there, not today.
"I've got too much cash in my bank account," Rachel continued. "There's the $100,000 payout from Isaac's life insurance, plus the $20,000 we had saved ... " Her voice trailed off as she remembered how they had planned to spend their golden years, before the accident swept Isaac out of her life forever ...
Click here to read Rachel's full story.
This post was part of a series which is now located on the Retirement tab. The series covers:
- The finances of Rachel, a hypothetical retiree, and the decisions she had to make.
- Key goals for any retiree.
- How to estimate a retirement budget.
- Home equity as a retirement asset.
- A reserve fund during retirement, mostly for medical expenses.
- Annuities that do (or don't) make sense for retirees.
- Managing income and payouts from your retirement savings.
A Rough Budget
To get a rough budget, you'll need to estimate your overall expenses, your sources of income, and how long you need your income to last. The method outlined here is meant to be a first step, an approximation. It will help you judge whether your income may enable you to reach your main goals. It won't answer every question, down to the last dollar. But it's a good start.
Here's an overview of the method, step-by-step. It has five "round numbers" that are close enough for a rough budget.
For worked examples of each step, click here to read the full article.
Here's an overview of the method, step-by-step. It has five "round numbers" that are close enough for a rough budget.
- Find Life+6, your life expectancy plus an extra cushion of six years.
- Use tax returns and account statements from last year, plus the inflation rate for the past 12 months, to estimate your annual expenses this year. This number is what you actually spent last year, including tax payments, but excluding income you saved, all adjusted for current inflation.
- Find your stable income from Social Security, pensions, income annuities, and reliable work, also adjusted for current inflation. Life+6 plays a part in calculating this number.
- If your stable income won't cover your annual expenses, find your spending balance. This is the amount available to extract from your spending account. As detailed in Enable Your Accounts, a spending account is a temporary reserve where you manage one or two years of living expenses.
- If your annual expenses are still not met, calculate the safe payout you can take from your retirement accounts and taxable savings. With Life+6, there's a simple, reasonable way to do this calculation. (Our Safe-Payout calculator does it for you, and offers other options, as well.)
For worked examples of each step, click here to read the full article.
This post is the first of three on inflation during retirement:
- Cost of living adjustment (COLA). Analysis of the 0% COLA for Social Security in 2015 (this post).
- Better ways to measure what this year's inflation really was.
- Predicting inflation next year, to better forecast your budget.
On October 15, the Social Security Administration (SSA) announced that there would be no cost-of-living adjustment (COLA) in 2016. Retirees, their dependents, and people on disability will receive the same monthly benefits in 2016 as they did in 2015. Some commentators have responded that real inflation for retirees and the disabled was greater than SSA estimated, and there should have been an increase in benefits. Who's right?
The answer hinges on how inflation is calculated. Let's consider these options:
CPI-U, one might argue, is a broader measure that includes non-wage earners, and might therefore be a better measure of inflation for retirees and those receiving disability benefits. But CPI-U also fell slightly from late 2014 to late 2015. Here, too, SSA's rules would have required the benefits to remain unchanged.
CPI-E would seem appropriate for retirees, but not necessarily for Social Security recipients younger than 62, such as widows, those on disability, and dependent children. An old, possibly outdated comparison of CPI-E and CPI-W found that CPI-E was about 0.3% higher than CPI-W, mainly because of higher expense for health care among the elderly. Applying 0.3% as an adjustment to SSA's calculations, the inflation rate would have been just under zero (-0.01%). Furthermore, in more recent data for the period 2002-2015, CPI-E has averaged the same as CPI-W. Either way, with newer or older data, CPI-E would not generate an increase in SSA benefits this year.
Finally, CPI for Basic Necessities would seem appropriate for retirees whose goal is to guarantee a "floor" budget for essentials, while allowing a flexible "ceiling" budget for discretionary items. Comparison of this index against CPI-W for the past 30 years indicates that CPI-W under-estimates inflation in basic necessities by about 0.26% per year. However, even after adjusting for the 30-year difference, the current inflation rate would still be less than zero. And it remains zero when CPI for Basic Necessities is compared for September 2015 versus September 2014.
The bottom line? No matter which measure of inflation you prefer, all of them estimate a slight decline in consumer prices for retirees, between late 2014 and 2015. Thus the decision is whether to cut benefits or leave them flat. Viewed in that light, SSA's announcement of no COLA may be more palatable.
The real concern? If overall inflation is not a valid concern, what is? I suspect two legitimate issues may be on people's minds.
The answer hinges on how inflation is calculated. Let's consider these options:
- CPI-U is the Consumer Price Index for All Urban Consumers. First introduced in 1978, it is estimated to cover the expenses of 80% of American households.
- CPI-W is the Consumer Price Index for Urban Wage Earners and Clerical Workers. Based on the original inflation index developed by the U.S. government in 1918, it is estimated to cover 32% of American households.
- CPI-E is the Consumer Price Index - Elderly. An unpublished, experimental value, it estimates the spending of households whose "reference person" (or their spouse) is 62 years of age or older, regardless of whether they are employed or retired. It covers about 24% of U.S. households.
- CPI for Basic Necessities. Also an unpublished, experimental value, this index covers the costs of food-at-home, shelter, apparel, energy, and medical care. It applies to the same 80% of households as CPI-U, but eliminates categories such as eating out, entertainment, and other expenses considered to be non-essential.
CPI-U, one might argue, is a broader measure that includes non-wage earners, and might therefore be a better measure of inflation for retirees and those receiving disability benefits. But CPI-U also fell slightly from late 2014 to late 2015. Here, too, SSA's rules would have required the benefits to remain unchanged.
CPI-E would seem appropriate for retirees, but not necessarily for Social Security recipients younger than 62, such as widows, those on disability, and dependent children. An old, possibly outdated comparison of CPI-E and CPI-W found that CPI-E was about 0.3% higher than CPI-W, mainly because of higher expense for health care among the elderly. Applying 0.3% as an adjustment to SSA's calculations, the inflation rate would have been just under zero (-0.01%). Furthermore, in more recent data for the period 2002-2015, CPI-E has averaged the same as CPI-W. Either way, with newer or older data, CPI-E would not generate an increase in SSA benefits this year.
Finally, CPI for Basic Necessities would seem appropriate for retirees whose goal is to guarantee a "floor" budget for essentials, while allowing a flexible "ceiling" budget for discretionary items. Comparison of this index against CPI-W for the past 30 years indicates that CPI-W under-estimates inflation in basic necessities by about 0.26% per year. However, even after adjusting for the 30-year difference, the current inflation rate would still be less than zero. And it remains zero when CPI for Basic Necessities is compared for September 2015 versus September 2014.
The bottom line? No matter which measure of inflation you prefer, all of them estimate a slight decline in consumer prices for retirees, between late 2014 and 2015. Thus the decision is whether to cut benefits or leave them flat. Viewed in that light, SSA's announcement of no COLA may be more palatable.
The real concern? If overall inflation is not a valid concern, what is? I suspect two legitimate issues may be on people's minds.
- First, if you don't drive a car, then your personal inflation rate is probably higher than average, perhaps between 1% and 2%, because you are not getting the full advantage of declining gas prices. You may be seeing only a small decline in utility bills or some modest savings on airfares or other transportation.
- Second, you may be concerned about the predictability of your budget. For example, looking ahead to housing and health care costs next year, you may expect them to rise. If they do, this year's 0% COLA means you will have to bear the additional costs for 12 months, until SSA calculates the next COLA in October 2016.
This post was part of a series which is now located on the Retirement tab. The series covers:
- The finances of Rachel, a hypothetical retiree, and the decisions she had to make.
- Key goals for any retiree.
- How to estimate a retirement budget.
- Home equity as a retirement asset.
- A reserve fund during retirement, mostly for medical expenses.
- Annuities that do (or don't) make sense for retirees.
- Managing income and payouts from your retirement savings.
The Plan
They had it all planned. Isaac would keep working until age 70, while Rachel, who left her job a few years ago, would work on her hobby, making jewelry. Once both were retired, they might tend the backyard garden properly for the first time in years and enjoy each other's company on road trips. Not long ones, though. They loved where they lived and had favorite day-trips and hiking trails they intended to re-visit as often as they liked.
When he was 66, Isaac had filed and suspended his Social Security benefits, which he planned to start at the latest possible date, after his 70th birthday. He liked his job and knew that delaying Social Security would increase his eventual benefit by 8% for each year he waited. Besides, his income from working would more than meet their needs. He could even afford to save some, which he did, in his employer's 401(k) plan. For insurance, he had a low-cost term-life policy that would pay about two years of his pre-tax income. It was due to expire when he turned 71.
Rachel, on the other hand, had recently started her own Social Security payments, soon after she qualified for full benefits. They were less than Isaac's payments would be, but she had decided to quit a job that bored her and get started on her crafts. For years, she had dreamed of using her artistic talents to make jewelry, and, without the pressure of working every day, she had a chance to begin. Her modest payments from Social Security helped her set up a studio in their home. Maybe, if all went well, she would one day be able to sell her jewelry at local craft fairs ...
To learn more about why Rachel's and Isaac's plans had to change, click here to read the full story.
When he was 66, Isaac had filed and suspended his Social Security benefits, which he planned to start at the latest possible date, after his 70th birthday. He liked his job and knew that delaying Social Security would increase his eventual benefit by 8% for each year he waited. Besides, his income from working would more than meet their needs. He could even afford to save some, which he did, in his employer's 401(k) plan. For insurance, he had a low-cost term-life policy that would pay about two years of his pre-tax income. It was due to expire when he turned 71.
Rachel, on the other hand, had recently started her own Social Security payments, soon after she qualified for full benefits. They were less than Isaac's payments would be, but she had decided to quit a job that bored her and get started on her crafts. For years, she had dreamed of using her artistic talents to make jewelry, and, without the pressure of working every day, she had a chance to begin. Her modest payments from Social Security helped her set up a studio in their home. Maybe, if all went well, she would one day be able to sell her jewelry at local craft fairs ...
To learn more about why Rachel's and Isaac's plans had to change, click here to read the full story.
An annuity that gives you guaranteed payments, for the rest of your life, may seem attractive. But it likely comes with fees and restrictions that may be hard to decipher. Furthermore, the net benefit to you may be less than you think, and more expensive than other options. Still, for some, certain annuities make sense. The key questions are:
- What's an annuity, and do you need one?
- How can you find the best annuities from the best companies?
- What annuities should be avoided, because better alternatives are available?
Worked Examples
Here are some examples of Single-Premium Immediate Annuities (SPIAs) and other options. They are based on actual quotes and real products, for a hypothetical married couple in their late 60's, seeking to invest $100,000 from an existing retirement account, with 100% benefits to be paid as long as either spouse lives. Although the quotes and products are genuine, I've made the companies anonymous because they may not operate in the state where you live, your age and other variables may differ, and the companies may impose contractual stipulations that depart from the quotes and website-data available to me. These examples should not be construed as recommendations to buy any particular security or insurance product. Rather, they are intended to illustrate how you might examine and evaluate annuity options applicable in your circumstances.
- SPIA-3%. This immediate income annuity raises its payments by 3% each year. The first year's payment is $4544, a 4.54% rate on the $100,000 deposit. With a COMDEX rank of 96, the insurer is among the top 30.
- SPIA-CPI. Also an immediate income annuity, this one increases its payments by the same percentage as the previous year's increase in the Consumer Price Index. Its first year payment is $4349, or 4.34%. The insurance company's COMDEX rank is 90, which puts it solidly in the top 100.
- Rider. This variable annuity is a partnership between a well established, highly regarded investment firm and an insurance company with a COMDEX rank of 92 (the top 60). Underlying the annuity is a mutual fund invested 60% in domestic and international stocks, and 40% in domestic and international bonds. The mutual fund, if purchased by itself, would have fees under 0.2%. Purchased as a variable annuity, it has additional fees of 0.29%. A guaranteed income rider adds 1.2% more. The total fees are pro-rated as 0.127% deducted automatically every month. In year one, for a $100,000 purchase, the annuity pays you $4500 (4.5%). Net, every month that year, the insurer deducts $501.67 from your account, paying $375.00 to you and $126.67 to itself. These values may change, depending on the performance of the mutual fund. It's possible for the annuity fees to increase while the payments to you remain flat. On the other hand, a legal rider to the annuity contract guarantees that payments to you will never decrease, and stipulates a formula by which they will increase if the underlying investments rise above their value at the time of purchase.
- Self-CPI. This option is not an annuity. It's a direct investment in the same mutual fund that underlies the Rider option. But the fees are lower, under $16 monthly, because none of the annuity fees apply, and the fund is held in an IRA account with no employer-related fees. It's a self-managed plan, where the investor uses the "collared inflation" method described here and implemented in our retirement income calculator. This method starts with an initial payment of $4020 (4.02%) because of the age of the hypothetical couple. It increases the payment each year by the smaller of (a) 6.7% or (b) last year's change in the Consumer Price Index. The limit of 6.7% is a "collar" which, historically, has been necessary to protect against depleting the fund in the worst case of 40+ years in retirement with inflation initially at extreme levels.
- From January 1972 to December 2014, a 43-year retirement with wide variation in markets and inflation.
- A 21-year retirement starting in 1973, when stocks crashed then rose, and inflation started very high.
- A 21-year retirement starting in 1994, when stocks and bonds both rose and fell, but inflation was low.
Retired 43 Years, 1972-2014
First, the good news. All four options provided payments every year for 43 years. Even better, the Self-CPI option had a residual value of $209,650, adjusted for inflation, in 2014. Yes, you read that right. With the money left in 2014, the investor's heirs would have had twice the buying power of the couple's original $100,00 investment in 1972. The annuities, as annuities, had no residual value. Instead, any profits went to the insurers.
However, because 43 years is a long time, because inflation was high in the 1970's, and because the period included multiple large swings in the values of stocks and bonds, the four options paid out very different amounts from year to year. The chart below shows how they differed, over time. It's important to note that in the chart, all values are inflation-adjusted to show constant buying power, pegged to January 1972.
However, because 43 years is a long time, because inflation was high in the 1970's, and because the period included multiple large swings in the values of stocks and bonds, the four options paid out very different amounts from year to year. The chart below shows how they differed, over time. It's important to note that in the chart, all values are inflation-adjusted to show constant buying power, pegged to January 1972.
Viewed in terms of buying power, the SPIA-CPI option was the clear winner. When adjusting for last year's inflation, it sometimes lost a bit of buying power if current-year inflation was high. But over the long term, it guaranteed constant income, in real, inflation-adjusted dollars.
The SPIA-3% option underestimated the high inflation of the 1970's and never caught up. Had this annuity been purchased with a 4% annual increase instead of 3%, the initial payment would have been a bit smaller, but the decline during high inflation would have been more limited. Eventually the initial buying power would have been nearly restored, as the compound rate of inflation for the entire 43-year period was 4.14%.
The Self-CPI option, because of its 6.7% cap on annual increases, fell behind inflation in the 1970's, but leveled out from 1980 onward. In effect, this method made a trade-off. It kept a large bequest as a result of cautious withdrawals.
The Rider option, when adjusted for inflation, fell short on its promise that payments would never decrease. Yes, in nominal dollars, the same amount was paid every year throughout the 1970's, but within a decade, inflation cut the buying power of those dollars in half. When huge bull markets in stocks and bonds began in 1982, the Rider option swiftly recovered, only to lose ground again after the dot-com bubble burst in 2000. Of all four options, this one had the least consistent payouts, adjusted for inflation.
The SPIA-3% option underestimated the high inflation of the 1970's and never caught up. Had this annuity been purchased with a 4% annual increase instead of 3%, the initial payment would have been a bit smaller, but the decline during high inflation would have been more limited. Eventually the initial buying power would have been nearly restored, as the compound rate of inflation for the entire 43-year period was 4.14%.
The Self-CPI option, because of its 6.7% cap on annual increases, fell behind inflation in the 1970's, but leveled out from 1980 onward. In effect, this method made a trade-off. It kept a large bequest as a result of cautious withdrawals.
The Rider option, when adjusted for inflation, fell short on its promise that payments would never decrease. Yes, in nominal dollars, the same amount was paid every year throughout the 1970's, but within a decade, inflation cut the buying power of those dollars in half. When huge bull markets in stocks and bonds began in 1982, the Rider option swiftly recovered, only to lose ground again after the dot-com bubble burst in 2000. Of all four options, this one had the least consistent payouts, adjusted for inflation.
Two 21-Year Retirements
The foregoing analysis comes with a big caveat. It's for a very long retirement in a unique historical period. Your experience in retirement will almost certainly be different. Consider, then, two other examples, both 21 years in length, one from January 1973 to December 1993; the other, from January 1994 to December 2014.
During these two periods, the underlying mutual fund of the Rider and Self-CPI options had compound, inflation-adjusted returns a bit higher than 5% per year. In this respect, the stock and bond markets were, overall, about average during both periods, despite some dramatic swings along the way.
At 21 years, both periods were also average in another sense. They fit the joint life-expectancy of a couple in their late 60's.
A key difference, however, is that in the first period, 1973-1993, inflation was abnormally high (6.05%), while in the second, 1994-2014, inflation was much lower (2.30%). Because of inflation, the SPIA-CPI option did the best job of maintaining payments at constant buying power in the 1973-1993 period; the other methods lost about 25%, falling close to $3000, inflation-adjusted. In the low-inflation period from 1994 to 2014, however, all the options preserved buying power, and the SPIA-3% and Rider payments actually bettered inflation. The chart below displays the average payments, after adjusting for inflation.
During these two periods, the underlying mutual fund of the Rider and Self-CPI options had compound, inflation-adjusted returns a bit higher than 5% per year. In this respect, the stock and bond markets were, overall, about average during both periods, despite some dramatic swings along the way.
At 21 years, both periods were also average in another sense. They fit the joint life-expectancy of a couple in their late 60's.
A key difference, however, is that in the first period, 1973-1993, inflation was abnormally high (6.05%), while in the second, 1994-2014, inflation was much lower (2.30%). Because of inflation, the SPIA-CPI option did the best job of maintaining payments at constant buying power in the 1973-1993 period; the other methods lost about 25%, falling close to $3000, inflation-adjusted. In the low-inflation period from 1994 to 2014, however, all the options preserved buying power, and the SPIA-3% and Rider payments actually bettered inflation. The chart below displays the average payments, after adjusting for inflation.
As shown in the next chart, only SPIA-CPI generated annual increases that kept pace with the 6% rate of inflation in the first period, while all the options matched or beat the tame 2.3% rate of inflation in the second period.
Finally, as with the 43-year analysis, the Self-CPI option was unique in preserving a bequest. Adjusted for inflation to reflect constant buying power, Self-CPI preserved principal approximately equal to the initial investment, in both 21-year periods: $90,756 at the end of 1972-1993, and $144,631 at the end of 1994-2014. The three annuities, by design, left nothing.
Summing Up
The examples presented here are for selected options and time periods. As such, they cannot be taken as guarantees of future performance or as definitive recommendations of certain products. Your results may differ, and will, as with any investment, entail a risk of loss. With those important cautions in mind, consider the following key insights from these examples:
- If one's goal were to guarantee constant buying power, SPIA-CPI would have been the best of the options examined above. A SPIA with a 4% or 5% annual increase might have performed comparably for periods of high inflation, but would have been more than necessary under normal levels of inflation.
- If one's goals were to preserve constant buying power and also leave a bequest, Self-CPI would have been the best of the options studied here. However, it would require active management by the investor (or by a paid adviser), which sets it apart from the annuity options.
This post was part of a series about managing how you spend your investments, if you aim to live long, live within your means, and, perhaps, leave some for others. The main ideas have been updated and moved to an article on Retirement Income, on the Retired Now menu. If you wish, you can still read the original series, using the links below.
- Retail strategies, using all-in-one mutual funds. Simple solutions that work for some.
- Insurance strategies, using Social Security and maybe some annuities. Part of everyone's plan.
- Endowment strategies, adapted from foundations and universities. Good for a reserve fund.
- Finance strategies, based on life-expectancy and future payments. Really good, simple methods.
- Smooth consumption, a comprehensive method that uses excellent, free software. This post.
Wandering
Imagine yourself as the following investor.
It's several years before you plan to retire. Looking back on your financial history, you recall your first job, first home, and first child. With some regret, you remember saving a pittance of your first salary toward retirement. You barely managed the down-payment on your starter home, and struggled to pay unplanned expenses for repairs and property taxes. And that new baby! You were so much in love with the darling that you foresaw few of the looming costs of pre-school care and future education, not to mention that all the kiddie-transport, soccer uniforms, and music lessons.
Now looking ahead to retirement, you've got some savings but aren't sure if it's enough. You think you might downsize your domicile but don't know how much it will boost your future income, or for how long. You dimly foresee a different budget, with less costs for children and more for health care, but that's not much help because your current budget is (let's be kind) an approximation. Yes, but you've become more intelligent about investing because, after all, your account balances have grown over the years. Then again, you're not sure if they might have grown more if you'd invested differently. Oh! And Social Security? You're starting that when?
Does this sound familiar? Like someone you know? Maybe even like you, or the old you before you got wiser?
If so, your financial path to this point wasn't a journey you planned. It was more like a wandering through time and sometimes turmoil, with ridges, ravines, and roundabouts along the way. If only you had some good advice, you think you could do better.
It's several years before you plan to retire. Looking back on your financial history, you recall your first job, first home, and first child. With some regret, you remember saving a pittance of your first salary toward retirement. You barely managed the down-payment on your starter home, and struggled to pay unplanned expenses for repairs and property taxes. And that new baby! You were so much in love with the darling that you foresaw few of the looming costs of pre-school care and future education, not to mention that all the kiddie-transport, soccer uniforms, and music lessons.
Now looking ahead to retirement, you've got some savings but aren't sure if it's enough. You think you might downsize your domicile but don't know how much it will boost your future income, or for how long. You dimly foresee a different budget, with less costs for children and more for health care, but that's not much help because your current budget is (let's be kind) an approximation. Yes, but you've become more intelligent about investing because, after all, your account balances have grown over the years. Then again, you're not sure if they might have grown more if you'd invested differently. Oh! And Social Security? You're starting that when?
Does this sound familiar? Like someone you know? Maybe even like you, or the old you before you got wiser?
If so, your financial path to this point wasn't a journey you planned. It was more like a wandering through time and sometimes turmoil, with ridges, ravines, and roundabouts along the way. If only you had some good advice, you think you could do better.
Gliding
An investment firm or financial planner might offer the advice you want. Condensed into a single phrase, it will be some version of this: De-risk your glide path. Huh? Let's spell it out.
All well and good. Just beware of two pitfalls.
First, the person generating recommendations for your plan is selling you products to achieve them. Not might be selling them, is selling them. One way or another, any investment firm or financial planner has some incentives to earn compensation, directly or indirectly, from the advice they give you. It might be a direct fee, a percentage of your assets, a sales commission, or an indirect charge in the expense-ratio of the funds they recommend. There's nothing inherently wrong with that, but buyer beware. And get a second opinion from someone with different incentives.
Second, in traditional financial planning, including typical online calculators, you set a target for your future budget. It's the destination of your financial glide path. It may be 75% of your pre-retirement spending. Or that amount with some puts and takes for expenses that vanish (like mortgage payments) and new ones that emerge (like Medicare premiums). But the target is necessarily imprecise. And it can't possibly be correct throughout an entire, decades-long retirement. Thus, in addition to getting a second opinion from an adviser with different incentives, you should get one from a different method that doesn't depend on a fallible target. Is that even possible? Read on!
- Know your risks. They are likely some versions of carrying too much debt, concentrating your investments in ways that are overly volatile, being under-insured for things you can't afford to lose, saving too little for known future expenses, and lacking reserves for life's unexpected turns.
- Manage the risks. The strategies for doing so may include reducing or refinancing your current obligations, diversifying your investments according to good principles, buying the right kinds and amounts of insurance, developing a plan to invest wisely now and spend smartly in the future, and finding a safe haven for some reserves.
- Have a glide path. A good financial plan will acknowledge that if changes are necessary, it may take some time to implement them. You will ease into your new budget, investments, insurance policies, and financial discipline. Like a target-date fund for retirement, your financial plan will have a path that starts with the turbulent uncertainty you have now and glides to the more cautious predictability you seek.
All well and good. Just beware of two pitfalls.
First, the person generating recommendations for your plan is selling you products to achieve them. Not might be selling them, is selling them. One way or another, any investment firm or financial planner has some incentives to earn compensation, directly or indirectly, from the advice they give you. It might be a direct fee, a percentage of your assets, a sales commission, or an indirect charge in the expense-ratio of the funds they recommend. There's nothing inherently wrong with that, but buyer beware. And get a second opinion from someone with different incentives.
Second, in traditional financial planning, including typical online calculators, you set a target for your future budget. It's the destination of your financial glide path. It may be 75% of your pre-retirement spending. Or that amount with some puts and takes for expenses that vanish (like mortgage payments) and new ones that emerge (like Medicare premiums). But the target is necessarily imprecise. And it can't possibly be correct throughout an entire, decades-long retirement. Thus, in addition to getting a second opinion from an adviser with different incentives, you should get one from a different method that doesn't depend on a fallible target. Is that even possible? Read on!
Smoothing
Consumption smoothing is a genuinely different method, and you can get it from a source with distinctly different incentives.
In consumption smoothing, the goal is not to set a target for a glide path to your retirement date. It's to find a standard of living for your household. The standard of living has to be achievable and stable. In short, the method computes how you can live within your means and live equally well throughout your lifespan. To do this computation, it gathers information about:
What if you don't like the answer you get from this method? Then you can adjust some of the data you give as input. By doing so, you can find out whether your lifetime standard of living would change if you saved more now. Or if you started Social Security at a different age. Or if you put more (or less) into a college savings plan and less (or more) into a reserve fund.
ESPlanner is patented software that implements this method. It was developed by two economists, Dr. Jagadeesh Gokhale and Prof. Laurence J. Kotlikoff, and is produced by Economic Security Planning, Inc. The incentives for this firm are simple: to sell you their software. The prices, however, are low, much lower than you would pay directly or indirectly to an investment firm or typical financial planner. Even better, there's a basic version that's completely free. It does a remarkably comprehensive job, and is available at basic.esplanner.com. To see how it works, you can get a nice example from this recent article by Prof. Kotlikoff.
ESPlanner won't sell you life insurance. Instead, it calculates how much life insurance you need (or don't need) and how the amount will change in the future, in order to protect your household's standard of living. It won't recommend any stocks, bonds, investment funds or bank deposits. But given your current and planned investments, it tells you the smooth, life-long standard of living they will enable you to have. It won't tell you when to take Social Security benefits or start retirement withdrawals. Experiment with possible dates, however, and it will calculate the impact on your standard of living.
A really nice feature is that each time you change the inputs, ESPlanner will generate tables showing, for every year in your anticipated life-span, the amount it calculates you will pay in taxes, the amount you should save that year, and the sources of your discretionary spending, whether from work, investment income, Social Security, retirement withdrawals, or prior years' savings. Look carefully at these tables, to see how you can stabilize your living standard by balancing what and how you save and spend over the years.
Getting started is simple. Watch two short videos at the website, then enter your data. It will take about an hour of your time, and will cost not one cent. More advanced versions will cost little and, as detailed on the website, they provide extra features you may want after trying the free version.
In consumption smoothing, the goal is not to set a target for a glide path to your retirement date. It's to find a standard of living for your household. The standard of living has to be achievable and stable. In short, the method computes how you can live within your means and live equally well throughout your lifespan. To do this computation, it gathers information about:
- Expenses you can't avoid, like housing and taxes.
- Your income now and in the future, whether from work, Social Security, a pension, or retirement accounts.
- Your household's changing characteristics, allowing for factors such as the temporary costs of children in college, and the dual incomes of spouses or partners whose work histories and retirement dates may differ.
- Your contributions to retirement and investment accounts, and to reserve funds.
- The tax-rates where you live and the ones applicable (or not) to your Social Security benefits and Roth or other retirement withdrawals.
What if you don't like the answer you get from this method? Then you can adjust some of the data you give as input. By doing so, you can find out whether your lifetime standard of living would change if you saved more now. Or if you started Social Security at a different age. Or if you put more (or less) into a college savings plan and less (or more) into a reserve fund.
ESPlanner is patented software that implements this method. It was developed by two economists, Dr. Jagadeesh Gokhale and Prof. Laurence J. Kotlikoff, and is produced by Economic Security Planning, Inc. The incentives for this firm are simple: to sell you their software. The prices, however, are low, much lower than you would pay directly or indirectly to an investment firm or typical financial planner. Even better, there's a basic version that's completely free. It does a remarkably comprehensive job, and is available at basic.esplanner.com. To see how it works, you can get a nice example from this recent article by Prof. Kotlikoff.
ESPlanner won't sell you life insurance. Instead, it calculates how much life insurance you need (or don't need) and how the amount will change in the future, in order to protect your household's standard of living. It won't recommend any stocks, bonds, investment funds or bank deposits. But given your current and planned investments, it tells you the smooth, life-long standard of living they will enable you to have. It won't tell you when to take Social Security benefits or start retirement withdrawals. Experiment with possible dates, however, and it will calculate the impact on your standard of living.
A really nice feature is that each time you change the inputs, ESPlanner will generate tables showing, for every year in your anticipated life-span, the amount it calculates you will pay in taxes, the amount you should save that year, and the sources of your discretionary spending, whether from work, investment income, Social Security, retirement withdrawals, or prior years' savings. Look carefully at these tables, to see how you can stabilize your living standard by balancing what and how you save and spend over the years.
Getting started is simple. Watch two short videos at the website, then enter your data. It will take about an hour of your time, and will cost not one cent. More advanced versions will cost little and, as detailed on the website, they provide extra features you may want after trying the free version.
Disclaimer: I have personally purchased and used ESPlanner software for my own household, but receive no compensation of any kind for recommending products sold by Economic Security Planning, Inc. Before using ESPlanner, you should read the product's disclaimers and disclosures.