Wednesday, July 10, 2019

My Preferred Planning Software is MaxiFi

I've been working on a research paper with UNC econometrician, Neville Francis for the past year and that has given me the opportunity to look at several free online retirement planners. Overall, I have to say that most were disappointing.

I have also worked for several years with another online retirement planning tool that is not free but is quite affordable, economist Laurence Kotlikoff's MaxiFi.[1] I recently asked Dr. Kotlikoff some questions about his product.

Dr. Kotlikoff, you say that MaxiFi is based on "consumption smoothing", the "proposition that households want to have a stable standard of living through time as well as across good times and bad times." What does that mean to a retiree or to someone saving for retirement?
Consumption smoothing is at the heart of economics-based financial planning. It's firmly anchored in human physiology. None of us wants to splurge today and starve tomorrow. Nor do we seek the opposite. Whether retired or still working, rich or poor, we're after the same thing — a highly stable living standard. Leaving aside issues of investment risk, the core financial planning question is how much to save each year to achieve a smooth consumption ride. MaxiFi calculates this directly based on your lifetime resources net of future taxes and gross of future Social Security benefits. In so doing, MaxiFi eliminates the guesswork in planning your retirement finances. It also helps you find investment strategies that limit your investment risk. In contrast, conventional financial planning asks you to set a goal for annual retirement spending. My goal is $1 billion.
A retirement planner recently commented to me that retirees don't all want "smooth consumption"; some want to spend more early in retirement. But spending more at some ages than others isn't inconsistent with "smooth" consumption, is it?  
MaxiFi has a Standard of Living Index that lets you tell the program you'd like to have a higher living standard earlier in life and a lower one later on. The tool will recommend discretionary spending that follows your desired living standard path as closely as possible subject to not putting you in debt. You can also specify special expenditures, like a major trip when you reach 70. MaxiFi will budget for this and have you pay for it by spending less ever year before and after the trip.
Most retirement planning tools measure success with "probability of ruin", or the percentage of simulated future scenarios in which a retiree can expect to not outlive their savings. Please explain why you prefer consumption smoothing.
Conventional planning is built on three mistakes. First, it asks people their retirement spending targets. Mine is $1 billion a week. So right away I've made a mistake. But even if I guess a "reasonable" number, I'm going to be miles off the level that MaxiFi will calculate. Second, conventional planning assumes you'll keep saving what you are now saving. That's mistake number 2. What you are now saving is surely wrong. The third mistake is assuming you'll spend your targeted amount year after year in retirement whether your assets go through the roof or fall through the floor.

Conventional planning's "probability of ruin" Monte Carlo simulations calculate the chance you'll run out of money if you make all three mistakes, i.e., if you a) save the wrong amount each year before retirement, b) spend the wrong amount year after year after retirement, and c) never adjust your annual spending once you retire. I can't fathom why anyone would wish to know the probability of financial survival in the context of making three major financial mistakes. Financial planning is supposed to help us make the right financial decisions, not tell us something we don't want to know about something we shouldn't be doing.
I can find lots of free "single-purpose" planning tools on the internet, tax planners, sustainable withdrawal rate calculators, life expectancy calculators, Social Security optimizers, RMD calculators, asset allocators, etc. Is there an advantage to incorporating them into a single program like MaxiFi?
All our financial decisions are interconnected. Take life insurance. You can't decide how much to buy until you know the living standard you need to insure. But your sustainable living standard (if no one dies) depends on the amount of insurance premiums you'll be paying. So, your living standard and life insurance needs must be jointly calculated. MaxiFi does this. It jointly handles all the factors you mention and more. The advantage of MaxiFi's integrated financial planning is that all its suggestions and calculations, including federal and state taxes, are absolutely internally consistent. If you use piecemeal calculators you'll get a set of suggestions that don't add up.
MaxiFi asks for only a few of my expenses as input. Why is that?
MaxiFi asks you to specify your "off the top" expenses on housing and other must-spend items, like alimony payments, out-of-pocket medical expenses, or college tuition. These expenditures are like negative income. Your other resources less a) these off-the-top expenses and b) your lifetime taxes determine your lifetime budget — what you can spend on a discretionary basis over the rest of your life. MaxiFi then smooths this spending. If we were to ask you to specify everything you were going to spend each year, year in and year out, you'd give us amounts that were either a) unaffordable or b) left some of your lifetime budget on the table.
Is MaxiFi a "Monte Carlo" simulator?
MaxiFi does Monte Carlo simulations on your living standard. It calculates 500 living standard trajectories you might experience based on how you are investing. It then compares these 500 trajectories with 500 based on investing more safely and 500 based on investing at greater risk. These trajectories take into account that you'll adjust your spending annually in light of how well your investments fare, always with the goal of having a stable living standard. Best yet, MaxiFi combines all of the 500 trajectories in a single index of your average lifetime happiness — what economists call your Expected Lifetime Utility. This index, which takes into account your tolerance for risk, lets you compare in terms of three numbers (one for each of the three sets of 500 trajectories) how your current investment strategy stacks up against investing at less or more risk. Lifetime expected utility maximization is the gold standard of economics-based portfolio guidance.
Can MaxiFi tell me if I should purchase life insurance or an annuity?
Absolutely. It calculates how much term life insurance you need to hold each year to ensure survivors have the same living standard to the dollar had you not died. It also shows you how much higher or lower your living standard will be if you purchase an annuity.
Can I perform what-if analyses with MaxiFi? What kinds of things can I test?
You can set up as many alternative profiles as you'd like and compare them against your base case in terms of their lifetime discretionary spending. For example, you can easily learn how much more you'll get to spend if you downsize or if you go back to work or if you switch jobs or if you annuitize your retirement accounts or if you wait to take your Social Security benefits.

But MaxiFi also does its own what-ifs for you. Once you run your base plan, MaxiFi asks you to MaxiFi It. When you run this report, MaxiFi looks for safe ways to raise your living standard by maximizing your lifetime Social Security benefits and finding the retirement account withdrawal strategy that will reduce your lifetime taxes.
Where can I learn more about how MaxiFi works?
Go to www.maxifi.com. Check out the videos, the case studies, and other descriptions posted there. And then try it! I promise, you'll get hooked on its ability to safely raise your living standard and finally take the guess work out of financial planning.
(Note: If you prefer video instruction, I have added two links below to recent MaxiFi Webinars.)[2,3]

Those are some of the reasons Dr. Kotlikoff believes MaxiFi's economics-based approach is best. Now, here's why I like it.

At $99 per year with $70 renewals, it's quite affordable for the do-it-yourselfer.

Dr. Kotlikoff and his team have steadily improved and refined the product, beginning with E$Planner, for over 25 years. That leaves the others with a lot of catching up to do with both the economics and the technology.

As a computer scientist, I know from experience that Dr. Kotlikoff has a top-notch technical staff and their help desk has always been available when I needed it with real people who know their product.

MaxiFi completely avoids the limitations of probability-of-ruin estimation. Instead, it incorporates consumption smoothing and maximizies the utility of achievable spending.

Many retirement planning tools address only the decumulation phase, when we retire and begin spending down our wealth. MaxiFi is a life-cycle planner and is useful at any stage.

Lastly, as Dr. Kotlikoff mentions, MaxFi integrates many calculations into a single model. Most free online simulators handle only a part of the problem, like maximizing Social Security benefits or modeling investment returns. Retirement planning isn't a problem that can be solved by solving many individual sub-problems independently.

If you're interested in financial planning software, give MaxiFi a try. You can use it to build a retirement plan or to create a "second opinion" of one you already have. It's also a good tool for your annual retirement plan checkup.

I rarely promote products at my blog but I know that many of my readers are do-it-yourselfers and many have expressed interest in software tools. I have a lot of confidence in MaxiFi. A multi-client version called MaxiFi Pro is available for advisors.

There are a number of new entrants into the online retirement planning field and I'll keep looking for free or affordable, unbiased, comprehensive planning tools. If you are especially fond of another tool that shares these attributes, please add a comment below.

To be clear, I don't believe that software can effectively replace a good human retirement planner given the current state of the technology, though the latter will no doubt cost more. I think you'd be way better off using a good human planner who uses good planning software. But for now, at least, I prefer MaxiFi for the do-it-yourselfer.



OTHER RESOURCES

Economist, Zvi Bodie now links to his "trusted sources" at https://zvibodie.com/trusted-resources/. I find the entire website very useful and particularly the videos.

NewRetirement.com provides a wealth of retirement planning software. I encourage you to take a look. Full disclosure, I act as an advisor to NewRetirement.


REFERENCES

[1] MaxiFi web-based planner, website.



[2] MaxiFi Webinar, June 26, 2019, VIDEO.



[3] MaxiFi Webinar, June 13, 2019,VIDEO.





Wednesday, July 3, 2019

The Best Inflation Protection You Never Heard Of

In a recent post, I discussed inflation's potential impact on your retirement income (see Remember Inflation?) and I warned against letting three decades of low inflation lull us to sleep.

Inflation rates are low right now, about 1.9% per year according to the U.S. Department of Labor. Even at that rate, a 2019 dollar in 2049 would purchase only $0.56 worth of goods and services in constant dollars of 2019 by the end of a 30-year retirement. Assuming the long-term average inflation rate of 3.15%, that dollar in 2049 would be worth only $0.38 in 2019 dollars.

Of course, there isn't a strong argument that inflation rates won't be significantly worse than average sometime in the next thirty years as they have been in four of the past eleven decades. The reality is that no can predict future inflation, mean or worst-case, with any certainty.

It is nearly certain that we will see some level of inflation over several years of retirement and even low levels will erode the purchasing power of nominal annuities and pensions. The only real question is how much.

Economist, Zvi Bodie and I recently published a paper[1] recommending that retirees consider purchasing CPI-adjusted annuities and CPI-adjusted bonds (TIPS)[2] instead of their nominal alternatives.

Retirees with pensions rarely enjoy inflation protection and when they do it is limited. I have several friends and family members covered by the Kentucky Teachers' Retirement System, for example. According to their website, their pensions currently offer a 1.5% cost of living adjustment which is much better than nothing but won't adequately compensate for historical average inflation or even today's low rate.

Annuities, whether CPI-adjusted or nominal, aren't the best solution for every household but there are other inflation-protecting alternatives to consider. TIPS are another choice for consideration but for this post I'll suggest U.S. Treasury Series I Savings bonds, or I Bonds.[3]

I Bonds are meant to be used as inflation protection for individual households and can only be purchased online at TreasuryDirect.gov.[4] The interest rate they pay consists of a fixed rate, currently 0.5% plus a variable inflation rate, currently 1.4% per year, that is recalculated twice a year. The fixed rate has been as high as 3.4% in 1998. These components constitute a "composite rate" that is currently 1.9% per year. Before you lose interest in a 1.9% return, consider several additional features of I Bonds that distinguish them from CDs or money market funds that don't compensate for inflation.


The best inflation protection you never heard of.
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CD's typically can be purchased with terms up to five years. I Bonds pay interest for 30 years.

The early withdrawal penalty for a CD depends on its term. A 5-year CD, if redeemed before the end of its term, will typically incur a penalty of about nine months of interest and a 1-year CD typically three months. I Bonds can't be redeemed for one year after purchase but there is no penalty for redemption after five years and only a 3-month penalty for redemptions between one and five years.

If I Bond interest rates decline, you have locked in your rate for up to 30 years. If rates increase, you can sell your old bonds and buy new ones, subject to annual purchase limits described below.

According to Dr. Bodie, "...another advantage of I Bonds is that [should interest rates rise,] investors could then cash out their existing I Bonds (and keep principal plus accrued interest) and buy new ones at the higher rate of interest. In other words, whether interest rates go up or down, the investor is protected. (But note that if you buy new I Bonds you would be subject to the $10,000 limit.) If you have the money, you would have to be nuts not to invest in I Bonds up to the limit."

I Bonds can never yield less than zero, so in the worst case your investment will maintain its purchasing power. In the event of deflation, I Bonds would increase in value.

From a tax perspective, according to TreasuryDirect.gov, I Bonds are somewhat similar to a non-deductible IRA in that tax on interest can be deferred. You don't have to pay taxes on earnings until the bonds are redeemed, though you can choose to pay annually if that benefits you. I Bonds are subject to federal income taxes but not state or local income taxes. CD and money market fund interest can be subject to all three if held in a taxable account and interest is taxed as it accrues annually.

I Bonds do have some drawbacks. A household can purchase a maximum of $10,000 per Social Security number per year. Still, that's $20,000 per year for a couple. Additional purchases can be made up to $5,000 per Social Security number per year if the purchase is made from a federal tax refund.

Some advisors suggest that the maximum annual purchase limitations mean I Bonds will be less interesting to households with a lot of savings. Perhaps, but I find them too good a deal to pass up even if I'd like to buy more (and I would).

I Bonds can't be purchased in a retirement account. Certain entities in addition to individuals, however, are permitted to open TreasuryDirect accounts including a personal trust, such as a revocable or "living trust."[5]

The real interest rate on I Bonds will be relatively low because they are extremely safe, backed by the U.S. Treasury and protected from inflation.

With the very low early-withdrawal penalties, I Bonds can be an excellent solution for investing an emergency fund or for any other future liability beyond one year and for protecting that investment against inflation. They are accessible by retirees with limited resources in denominations as low as $25. Even households with large retirement savings may want to max out I Bond purchases before buying TIPS.[6]

It's a struggle to find retirement strategies for under-saved households but I Bonds provide one. Households that are able to save some of their early-retirement income from pensions and Social Security benefits could use those savings to purchase I-bonds that would then provide inflation-protected consumption later in retirement.

To find out more about Series I Savings Bonds and how to purchase them, go to TreasuryDirect.gov. Creating an online account at TreasuryDirect.gov is currently the only way you can purchase them. If you prefer video explanations, please see the links below.

TIPS: (the old-fashioned kind) TreasuryDirect.gov is an excellent informational website but it could be a better e-commerce site. Don't enter "TreasuryDirect.com" into your browser (it's "TreasuryDirect.gov"). Likewise, don't enter "Treasury.gov", that's a different website. To purchase I bonds, go to the homepage "TreasuryDirect.gov" and click on the green "Open an Account" link toward the upper right.


REFERENCES

[1] Hedging Against Inflation with Real Annuities, Zvi Bodie and Dirk Cotton.



[2] TIPS in Depth, TreasuryDirect.gov.



[3] Series I Savings Bonds, TreasuryDirect.gov.



[4] America’s Best Kept Financial Secret: I Bonds, Zvi Bodie on PBS.



[5] How To Transfer I Bonds to an Entity Account, TreasuryDirect.gov.



[6] Comparing I Bonds to TIPS, TreasuryDirect.gov.



[7] How to Buy Digital Savings Bonds Online, VIDEO.



[8] How to Buy Digital Savings Bonds as Gifts, VIDEO.



[9] How to Protect Your Nest Egg from Inflation, Zvi Bodie, VIDEO.



[10] Guided Tour for Opening an Individual Treasury Direct account, TreasuryDirect.gov.