For years, Boston University economics professor Larry Kotlikoff has advocated for consumption smoothing — essentially creating a sustainable living standard that “smooths” out over a person’s lifetime. He’s even created a software solution that gets the job done.
But the advisory community has overall ignored the economist’s top counsel: that economics-based planning replace traditional financial planning. That could be changing.
The Retirement Income Industry Association recently named Kotlikoff, 58, the winner of its Achievement in Applied Retirement Research award in acknowledgment of his influence in the field of retirement income management and financial planning. (Disclosure: Research Editor Gil Weinreich chaired the committee that selected the award-winner.)
PROFESSOR OF ECONOMICS, BOSTON UNIVERSITY
PRESIDENT, ECONOMIC SECURITY PLANNING
“Financial planning done right is rocket science and what they’re using is 14th century medicine when we have penicillin.”
With retirement income planning now in the national spotlight, RIIA Chairman Fran?ois Gadenne said consumption smoothing, ignored by most academics, is likely to emerge as a hot topic.
“He’s tackled a problem that’s central to the topic of retirement, not so central to the topic of wealth accumulation,” notes Gadenne.
“He’s got the academic piece and for the last 20 years he’s been trying to implement his idea in a startup in a software package. Net net, that makes him a pretty interesting guy — a guy who is involved with two interesting things that may be coming at the right place at the right time.”
Kotlikoff says much of the traditional financial planning being done today is faulty because it focuses on selling products rather than helping people raise their living standards. As well, he adds, it often involves setting spending targets that are too high and putting investors in risky assets.
“That game is over, people have gotten too burned. We’ve got to focus on the living standard again, which is what people care about,” he says. “Economics has been focused on this problem since 1920 — we have almost 100 years of economic research and now there’s finally software [to implement it.] Planners need to listen up. I compare it to medicine. What if we had the medicine that could cure infection and didn’t tell anyone? Because you’re making money the old way, that’s why.”
The software Kotlikoff has developed at his private venture, Economic Security Planning, materially raises people’s living standards by answering such questions as: Will this new job mean more spending power? When should I take Social Security? Am I getting a fair divorce settlement? Should I pay down my mortgage? Are 529 plans worthwhile? Should I convert my IRA to a Roth? How should I factor in my state and federal taxes? If I move to Cedar Rapids, Iowa, will it raise or lower my living standard?
“Our software can answer a question in two seconds. If you looked at our computer code, it would be the equivalent of five encyclopedias high,” says Kotlikoff, who has authored or co-authored 13 books, most recently Spend ‘Til the End: The Revolutionary Guide to Raising Your Living Standard — Today and When You Retire. “Getting these choices right can make a huge difference to your future living standard. If you don’t do this stuff very, very carefully, you’re not going to get anywhere with [financial planning] advice. You can’t give portfolio advice until you know everything about a client’s living standard floor. What our software can do is find the bliss point.”
Kotlikoff, the first to come to market with such software, used dynamic programming, a mathematical technique for solving complicated problems. A simplified version is available at esplanner.com, free to the public. The professional one is subscription-only.
His best advice for advisors? “Try and build a living standard floor, a safe floor under your clients’ futures and consider technology that can do that for you quickly and easily. Really, it’s a great time for financial planners in terms of really considering what economics has to say here. And hang in. It’s a tough time for everybody.”
Kotlikoff, who got his Ph.D. in economics from Harvard in 1977, has served as a consultant to corporations, institutions and governments across the globe. He has opinions on lots of things and has been published extensively. He’s got a fix for health care, the financial system, Social Security and the World Bank.
His upcoming book, Jimmy Stewart is Dead, declares that old-line banking is dead. (Stewart famously played a small-town banker in It’s a Wonderful Life.) In its place, Kotlikoff proposes something he calls “Limited Purpose Banking.” Under his plan, all financial corporations engaged in financial intermediation would function exclusively as middlemen who sell safe as well as risky collections of securities to the public. However, they would never themselves own financial assets — thereby making financial services organizations, as Kotlikoff puts it, “the disinterested intermediaries they pretend to be.”
Kotlikoff says he’s so deeply involved in trying to help shape policy because it’s why he went into economics in the first place: to help people, to help society, to make a contribution.
“I don’t sleep too much. I get to travel a lot, meet a lot of fun people and I was just in Europe with my 11-year-old son while I gave three talks there. He got to see things most 11-year-olds don’t see at this point. I think I regret being a little overcommitted all the time,” he adds. “But when I see a problem, it gets my adrenaline going. I just can’t help it.”
Baltimore Sun,” can be reached at firstname.lastname@example.org.