Conventional Consumption smoothing not realistic
I have provided input in ESPlanner and run the Economic’s based planning method. The results provide me with about $90,000 consumption and that is in line with my needs for meeting the expenditures that I anticipate for our life style. That is good as I am 12 to 18 months from retiring.
Then I run the Conventional planning method for comparison using $90,000 for the discretionary retirement-spending target starting in 2011 with the same input data as for the Economic’s method. The result calls for a consumption rate for the next year of over $500,000 wiping out all my regular assets and then goes to $90,000 per year for the remainder of time. I set the start date for 2012 and the program provides two years of $320,000 consumption per year. Each time the Regular Assets on the Net Worth page plunges negative. This is an absurd suggestion and must be based on an input data point that I can’t figure out. The maximum indebtedness is set at zero. I played around by adding a Reserve but it only makes things worse. Now I wonder if there is something wrong with my input, are the results from the Economic’s planning method in question.
My case is relatively simple:
• One primary home with mortgage
• No children
• Married with retired spouse
• Income for the next 12 to 18 months
• Regular after tax assets
• Retirement accounts
• Special receipts account for a deferred compensatio program for ten years
• Start Social Security benefits at 70
• Assumptions are default values and nominal rates of return of 8.5%
Can you advise what parameter may be incorrect to produce this result?
Dick
RSS
Conventional planning assumes no borrowing constraint. It's the only way to get the math to work out to show you the defects in conventional planning.
Best,
Dick Munroe
Dick,
Thank you for the quick reply.
I am not sure that I appreciate the defect in the conventional planning when it seems at face value that this result is more likely a programming or logic error. A suggestion to splurge and spend all my regular assets for one or two years, followed by an appropriate target level of consumption at 20% of the splurge, and in addition go into debt doesn't seem rationale.
I do understand the shortcomings of the conventional method, however this seems like a strange way to make the point.
In any case, I am now more confident in my input and the results from the Economic Approach.
I appreciate your response.
Dick
No, you've told ESPlanner that you're planning on spending 90K/year from a given time on. The "splurge" is probably necessary to lower your asset level to the appropriate number so that you can then spend only 90K/year. Not having seen your database I can envision any number of mechanisms by which this sort of recommendation can result. I would presume that if you run your profile using economic based planning the number you get for consumption is > $90K/year,
In other words, not necessarily a bug.
The basic assumption ESPlanner always makes is to spend everything you've got on the table. The above plan should do that.
If you DON'T want to spend everything, then there are a number of ways to do this:
(1) Contribute to a reserve fund that you never spend. It will show up as part of your estate.
(2) Leave a bequest. It will show up as part of your estate.
(3) Insert one or more special expenditures in the year of your death which correspond to bequests or gifts. These won't show up as part of your estate, but ESPlanner will plan for their existence and lower the yearly spending appropriately.
You can also use the assumptions screen to lower your living standard during retirement. You SHOULD see an effect similar to that of turning on conventional planning, i.e., consumption goes up early on because you're spending less than you could later on.
BTW, there MAY be a bug, but without your opening a support ticket and uploading your database it will be difficult to tell you anything definite. My gut tells me that the right things are happening but that's been wrong before.
Best,
Dick Munroe
Dick,
That description helps me understand what is going on. I increased the spending target and the results become more reasonable. It is interesting that the conventional results would indicate a higher consumption than the Economic Approach. Your suggestions give me ideas and opportunity to explore different options and sensitivity analysis. I have more confidence in the Economic Approach with Monte Carlo. But now these comparative results along with other simulations give me a better understanding of what is possible.
I find ESPlanner very helpful in my planning for the future.
Thank you again for your response and help.
Dick
I have found ESP to be generally very helpful in conjunction with other planning tools available. I value ESP most for its careful tax calculations but not for its UI or its obviousness of implementing my plan assumptions. I got encouraged when I saw the conventional planning option but quickly found it too limited to accomplish much of anything useful, other "conventional" retirement planners provide less counter intuitive results that largely reflect the ESP economic results when the same assumptions are used (say, use the ESP suggested consumption, adjusted to match the other plans' definition of consumption and plug in ESP taxes) and the results pretty well matchup.
Three comments on this:
Conventional planning ignores any change in standard of living you have entered which seems bogus if comparing two approaches is the purpose.
All other conventional planning I've used let's you expressly provide consumption/spending amounts and indicates a "leftover" amount at plan's end. In fact, what this implementation proves is not that conventional planning is poor but that your interpretation is not really conventional planning (am I misunderstanding what your use of conventional means here?)
Finally, all the approaches you suggest for a "leftover at end" result in extra money being taken out each year from retirement savings with the associated tax consequences. What I really want is to have a given amount of money left in the last survivor's tax advantaged accounts. I don't really understand why this is so hard - but who knows what the code looks like by now. I have been unable to use smooth withdrawal options to do anything useful but that's another question I'll ask elsewhere.