A comment to my recent post reviewing the ESPlanner software guided me to a finance professor named Sherman Hanna, who created a consumption smoothing spreadsheet, called LCS. The commenter was curious how this (free) LCS spreadsheet compared to the fairly expensive ESPlanner software ($149 for the basic, $199 for the premium with Monte Carlo simulation).

I did a basic test using my family as a test case. My family consists of myself (33), my wife (32), and my daughter (2), with another child expected in the next year. I started with $70K in retirement savings and approximately $120K/$100K in pre/after tax earnings. I assumed we paid for both childrens' college in full, at a price of $20K per year per child (today's dollars). I tried to put the same inputs into both software, although it's not always possible (ESPlanner wants pretax income, and LCS after-tax; ESPlanner calculates Social Security for you based on your earnings, and LCS wants you to input expected SSI, for example). I assumed early retirement at age 60, and taking SSI at age 70, with 75% of the projected benefit. The results? A huge variation between the programs. Here are my observations.

Inputs into LCS were much simpler. The program only needed a few basic numbers to give you a initial estimate. I'd venture that the estimate is only as good as the numbers you put in though. Digging deeper you find that most of LCS assumptions can be changed manually, which allows as much or as little detail as one would want. ESPlanner requires a thorough breakdown of most aspects of your finances. ESPlanner, while somewhat rough around the edges, is several orders of magnitude more streamlined in its interface. With LCS, you pretty much need to know Excel inside and out.

Outputs from LCS are pretty rough as well. Printing a pre-defined print-area will give you some basic summary info in both table and graph form. ESPlanner's output is better, starting with a formatted PDF summary document, along with supporting spreadsheets (ESPlanner uses Excel as the engine to do its calculations).

However, the biggest difference between the two is the handling and definition of "consumption". ESPlanner defines household consumption as gross after tax spending minus housing expenditures (mortgage, tax, maintenance, insurance). Housing expenses are entered in detail fashion (including loan info and schedule). Then ESPlanner calculates a household factor which is based on the number of adults and children. It assumes some economies of shared living. So 2 adults can live together as cheaply as 1.6 singles (by default). Children are handled in a similar fashion. It divides the household consumption by the household factor to give the "consumption per adult". Then it attempts to smooth the consumption per adult over the family's lifetime. The whole approach seems reasonable to me, and the economies of shared living data is based on studies that have been done.

On the other hand, the LCS approach is somewhat different. The LCS formula uses a complicated ratio of household size, likelihood of death, and "thriftiness factor" to approximate the change in spending from one year to the next. All expenses are lumped together, including housing, and no allowance is made for paying off loans. This causes spending to change relatively slowly from year to year, even if the household changes size drastically. This approach does not seem as intuitive or reasonable to me as the ESPlanner method.

The two programs produce drastically different spending plans in our case. Here is a chart detailing the 2 different savings plans.
Here is a chart detailing the 2 different spending plans.

ESPlanner recommends saving only $9000 this year (including all retirement contributions), with savings generally growing up to about $20K just before college, whereupon savings basically stops, resuming gradually as each child graduates, and peaking at $55K just before retirement. This produces a living standard per adult of $35880 in today's dollars up to age 100. Remember that ESPlanner does not include housing costs in consumption. Including housing, total household spending is in the range of $90-95K pre-college, and around $65K afterward (the "Empty Nest" phase).

LCS recommends saving $20K this year, increasing to $32K in 2 years, and then gradually decreasing to around $20K by the time the kids reach college. Household spending (including housing) starts at $80K and basically rises continuously throughout life, reaching a peak of $105K at age 75, and then gradually declining to $66K at age 100.

Since these plans are very very different, they obviously cannot be both be right. For me, it comes down to whether you think spending follows the ESPlanner model (non-housing spending is strongly correlated with household size) or the LCS model (overall spending grows throughout life and changes very slowly with household changes). Also, ESPlanner's treatment of housing expenses as separate from consumption seem more logical to me. Your housing expenses would not change much if a child moved out, but your food and entertainment costs would likely see big drops. LCS seems to make only a small allowance for this. Also, the fact that ESPlanner allows for loans to be paid off is a big plus for me. In LCS, it is probably possible to enter housing costs manually as line item expenses which could be drastically reduced when a loan is paid off, but I have not tried this as of yet.

The big price tag for ESPlanner will likely discourage many but I believe the accuracy of its planning tools makes more sense for detail-oriented planners. On the other hand, LCS freeware nature, combined with a more conservative spending model, will probably suit many just fine.

LCS can be downloaded from

I recently purchased ESPlanner from www.esplanner.com. The software is a financial planning package developed by Laurence Kotlikoff, Professor of Economics at Boston University, and Dr. Jagadeesh Gokhale, Senior Fellow at the Cato Institute. Having played around with it for about a week, I figured I would post my initial thoughts.

First, the idea of the software is "consumption smoothing". In other words, the goal of the software is to attempt to generate a level standard of living throughout the user's life. It does this by varying the amount saved or dissaved year-by-year. I think this is a great concept, because it is a more holistic approach, taking into account changes in household size (children being born and moving out), housing costs (buying or selling a home), large one-time purchases (vehicles, vacation homes, etc), and one-time windfalls (inheritances), as well as a host of configurable events, or ongoing or recurring situations. The software creates a detailed plan on how much to save or dissave (spend down savings) each year in order to maintain a smooth living standard per adult. ESPlanner takes into account economies of scale, so a 2-person household can live as cheaply as 1.7 single-person households. Likewise, as household members are added, there are similar economies of scale. It is very computationally intensive and generates a lot of data in spreadsheet form, along with a consolidated PDF summary report.

Now to the negatives. The design of the software is quite spartan. The interface reminds me of freeware, which is not a compliment. I noticed a number of small bugs, none of which made the software unusable but were nagging nonetheless.

For younger people, I would take ESPlanner's recommendations with a grain of salt. The software requires many detailed projections of expenses, income, savings, household changes, etc. Any error in these projections could have a big effect on your plan and could throw off your projections. For older people who are approaching retirement, the variables are fewer and less fuzzy, and the projections are probably more accurate.

As the year draws to an end it's time for a little 2009 tax planning. We are not planning any major changes unless we get pregnant with #2. If that happens early in 2009 we'll have to make some substantial changes, but as my dad likes to say, we'll burn that bridge when we get to it.

In 2008, we did a fair amount of jumping around with our retirement contributions, initially starting out very low, then increasing them as the year went on. My goal for 2009 is to keep a more "averaged" path, so we are setting my wife's 403b contributions to approximately 25% of gross. I am again planning to max out my SIMPLE IRA. Since the 2009 max has gone up to $11,500, that equals out to $442 every 2 weeks, or about 14% of my gross. Together it comes out to around 17% of total gross, with everything going in pre-tax. This is about the same as what we did last year on average.

We will probably not max out our Roths this year because the above strategy keeps us very close to the top of the 15% tax bracket. If we wanted to fully fund the Roths we would have to cut back on our pre-tax savings, and those Roth dollars would be taxed at 25% going in. We plan to put about $2K into the Roths this year, which could end up being either college money for our daughter or retirement money, depending on how things go.

Additional extra cash flow will go towards paying down our HELOC so we can keep our 6 month emergency fund in place.

Of course, if #2 will end up being born in 2009, the extra exemption will allow us to contribute less pre-tax and still stay in the 15% bracket, so the Roth contributions would get adjusted upwards. The extra $1K child tax credit wouldn't hurt either.

I wanted to go over my investing strategy, since it seems a little unorthodox (but really isn't). My wife and I follow Scott Burns' 10-speed portfolio. Mr. Burns (a finance columnist for the Dallas Morning News and USAA) is more famous for his Couch Potato portfolio, which is equal parts Total Stock Market index and Treasury Inflation Protected Securities. Since this is 50% bonds, it is a bit conservative for me (although ironically it has outperformed the S&P 500 over the last 5 years).

Luckily, Mr. Burns has created more complicated versions of his CP portfolios, with equal parts of different asset classes, up to the Ten-Speed, which has 10 equally-sized different "blocks" in it. Here is the breakdown of the Ten-speed:

Block 1: Domestic total stock market
Block 2: Treasury Inflation Protected Securities
Block 3: International total market
Block 4: International bonds
Block 5: REITs
Block 6: Energy
Block 7: Large U.S. value stocks
Block 8: Small U.S. value stocks
Block 9: Emerging markets
Block 10: International value stocks

The reasons I like this portfolio:

-It is aggressive. With 80% equities, it fits my risk profile. In my case, I slightly modified Block 4 to use International Inflation-Protected Bonds, so all my bonds will keep up with inflation. I see inflation as a big problem in the future with all our government's pending obligations. The only real way to fund these obligations will be to print lots of money, which causes inflation.

-It is simply to implement and maintain. Simply total your portfolio, move the decimal point one digit to the left, and you've got your allocation in each block. Rebalancing is just as easy.

-It can be very cheap to own. I use Vanguard funds and ETFs whenever possible. Because of this, the average expense ratio for my portfolio is around 0.50%. I have read numerous studies that the best indicator of future performance is low expenses. Almost all of the 10-speed blocks are available as index funds or ETFs, which makes it relatively easy to find cheap choices for the blocks.

-It is diversified. With about 27% in large cap US stocks, 13% in small cap US stocks, 20% in international stocks, 10% in emerging markets, 10% in REITs, and 20% in inflation-protected bonds both here and abroad, it is not concentrated in any one asset class. This meshes nicely with David Swensen's investing strategy. Swensen is the incredibly successful manager of Yale's endowment, which has returned over 15% a year for the last 10 years. Swensen does not advocate holding large portfolio holdings in any one asset class.

The one thing I don't like about this fund is that it can require a lot of money to fund the minimums on 10 funds. Since our retirement accounts are split between 4 different accounts, we couldn't have 10 funds in each account and still make the fund minimums. The way I have gotten around that is to spread the 10 funds over 3 of the accounts. The 4th account is a 403b which has limited fund choices, so I use a more traditional asset allocation there. Once we've gotten large enough balances built up in the other 3 accounts, I plan to institute 10-speed portfolios in each one, which will make management easier.

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