Making it Simple
Danilo and Gina Perez live in New York City. They are 30 years old and plan to have a child in five years and retire at 65. They are both busy bees with a typical, but also highly complex economic life. They want to have a stable living standard per household member over time, but don’t know how much to spend each year to make this happen.
There are lots of factors at play—wages, taxes, their prospective extra mouth to feed and his/her college expenses, mortgage payments, contributing to retirement accounts, life insurance premiums, collecting Social Security, paying Medicare premiums, rates of return on investments, inflation . . .
Danilo and Gina are very smart, yet flummoxed by all these factors. They shouldn’t feel bad. PhDs in Economics couldn’t solve the Perez’s consumption-smoothing problems on their own.
Doing so requires sophisticated consumption-smoothing software. ESPlanner—the first and, to date, only consumption-smoothing planning program available to the public—can deal with all these factors and more in a matter of seconds.
The dotted red line in the graph shows what ESPlanner recommends the Perezes spend on consumption each year. Consumption refers to all spending apart from taxes, housing, insurance premiums, retirement account contributions, special expenditures, and saving. i.e., consumption is the household’s discretionary spending.
The dotted red line shows more spending when their child arrives and less once he/she reaches age 19 and heads off to college. This recommendation—consume more when there are more mouths to feed—is consistent with a perfectly stable living standard per person over time, which is shown in the dotted blue line.
The purple line shows total expenditures on consumption, housing, college, insurance and Medicare premiums, retirement account contributions, and taxes. Changes over time in the purple line reflect not only changes over time in the level of consumption, but also the fact that the household’s real (inflation-adjusted) mortgage payments are falling over time, that college expenses are time-limited, that Medicare premium are projected to rise significantly during the Perez’s retirement, that taxes vary through time, and that retirement account contributions stop at retirement. The chart also shows the Perez’s income changing through time. Income refers to their labor earnings, assets income, retirement account withdraws, and Social Security benefits.
The amount the Perezes need to save each year changes dramatically over time. This is a far cry from traditional planning’s recommendation that the households save a fixed amount or at a fixed rate each year. ESPlanner tells the Perezes to save when they can and dissave when they need to. Given the changes that the Perezes face over time in their income and off-the-top expenses, fixing their saving amount or saving rate would entail huge variations over time in the Perez’s living standard. Thus conventional advice entails consumption disruption, not consumption smoothing.