What Economists Know That Many Financial Advisors May Not (But Should)

4 minute read

“The whole goal of our life is not to accumulate wealth so people can charge us fees on our assets. It’s having the best lifestyle we can, given our resources, so we don’t end up living on the street if the market crashes, or the house burns down, or we live to be 100 years old.”

–  Larry Kotlikoff, Barron’s 9/10/21 interview

Making financial decisions in life is difficult says Larry Kotlikoff, Professor of Economics at Boston University, and a recent guest on the Alliance’s “Your Money Map” show hosted by Jean Chatzky. Making financial decisions for retirement is even tougher. As one of the world’s 25 most influential economists, Kotlikoff talks about these problems and offers practical solutions for retirement planning in his new book Money Magic: An Economists Secrets to More Money, Less Risk and a Better Life.

Kotlikoff has spent years researching the problems and complexities of retirement planning and translating that into an economics-based financial planning approach to help people think about their finances in retirement. Though economists are great at identifying problems and developing financial models, they’re not often as good at offering practical ideas and solutions to avoid the many retirement planning mistakes people make.

Kotlikoff wants to change that perspective and says in his book, “I’m also keen to demonstrate that economists can do more than study people’s financial mistakes. We can also prescribe financial penicillin – all the things you can and should do to ensure a steady, secure, and higher lifetime living standard.”

Kotlikoff believes many financial professionals still use conventional financial advice that he describes as “a collection of crude rules of thumb.” Some of these rules of thumb, outdated for today’s world include:

  • You’ll be able to set a target for how much you spend in retirement that is exactly correct or by using an income replacement rule (e.g., 4% withdrawal) to determine how much you can withdraw from your savings.
  • You’ll keep spending the exact same amount no matter what happens to your assets and/or changes in your household.
  • Retirement planning should be done by estimating your “probability” of success.

Conventional financial advice, he says, should be replaced by financial planning that calculates rather than guesses at what to do.

Kotlikoff offers three important retirement planning ideas worth considering:

  1.  Balance Spending and Saving. To achieve a higher overall standard of living, focus on consumption smoothing, which is creating a balance between spending and saving during different phases of our lives. Saving for retirement is the quintessential step in consumption smoothing, but you don’t want to under- or over-save. You want to get this right.
  2. Calculate Your Spending Needs. Look at your lifetime resources and figure out what you should spend so you can keep spending – not how much you’d like to spend in retirement. You can only spend what you have. Once you know what you have, you know what you can spend.
  3. Get Your Maximum. If at all possible – and after figuring out your expected lifetime income based on all of your savings and assets – wait until age 70 to start claiming Social Security. Most Americans don’t realize they’re leaving hundreds of dollars on the table each month by claiming early. SSA adds an 8% delayed retirement credit each year you hold off, until age 70.

Protected Income

Kotlikoff has offered a variety of other practical retirement planning ideas over the years, including how to adjust your retirement thinking by focusing on income not just savings, and why people should consider annuities.

For decades, economists have wondered why Americans don’t use annuities more, which like Social Security, provides protected lifetime income in retirement. The problem is important enough to have it’s own term – the annuity puzzle. Two Nobel Prize winning economists – the noted behavioral economist Richard Thaler, and the late Franco Modigliani who coined the term during his acceptance speech in 1985 – have researched and explored solutions to the problem for years.

Annuities have protected and provided retirement security to millions of Americans for hundreds of years and are a proven solution for the many risks we face in retirement, including longevity risk and the risks you face with market volatility.

WATCH Your Money Map: What Economists know that your financial advisor may not

Larry Kotlikoff, acclaimed economist and author of Money Magic, joined Jean Chatzky on Your Money Map to discuss what economists know that your financial advisor may not on February  23, 2022.

The key thing about a real annuity is that it provides insurance against perhaps your greatest financial risk – continuing to live.

– Larry Kotlikoff, Austin American-Statesman, 5/10/17

Kotlikoff recommends anyone planning for retirement should consider annuitizing their retirement accounts and has written about the importance of annuities in his research and books. To show the financial and emotional power of annuities, he wrote a very personal article in the Austin American-Statesman in 2017, describing how he and his siblings would have made a big financial mistake had they not purchased an annuity for their mother.

Learn more about the value and power of annuities by using some of these simple tools and guides to protect and live the lifestyle you want in retirement, and watch the Your Money Map conversation with Jean Chatzky, featuring Larry Kotlikoff on Facebook Live

Larry Kotlikoff is a Professor of Economics at Boston University. His writings and research address personal finance, Social Security, inequality, taxation, climate change, investing, healthcare, deficits, and insurance. His most recent books are Money Magic and Get What’s Yours, a NY Times Best Seller co-authored with Philip Moeller and Paul Solman.

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