Wh What Are We We Do Doing Here? We Were re trying to fi - PDF document

Introduce ESPlanner Aa Aaron Stevens EC1 EC171 71, 18 18 October 2011 1 Wh What Are We We Do Doing Here? We We’re re trying to fi figure out how much to c to consu onsume (C (C) a ) and nd sa save ve (S (S) e ) each year, year, gi given en our ur labo abor r inco come e (W). The The ec economic life-cycle model t tells ho how w to smooth h our consumption, bu but it get gets s com compl plicat cated ed on on accoun account of: of: • time value of money • taxes and benefits • borrowing constraints • computational complexity

Wh What is ES ESPlanner? ESPl ESPlan anner er is is a software pr program whi which h do does consumption smoothi hing, gi given ven your: your: • ag age, household composition • la labor supply • as assets and liabilities • ta taxes • bo borrowing constraints Free Free vers ersion online e at at: www. www.esplan anner.com/bas /basic St Steve St Stifler, ag age 22 Steve Steve jus ust t got got a a job ob in n mar arketi keting, ng, ear earni ning ng $44, $44,000 000 per per year year; he e expec expects ts to to ear earn $75, $75,000 000 (in n tod today ay’s s dollars) by the time he re retire res a s at a age 6 65. • St Steve’s s broke -- no assets. • $8 $8,000 in credit card debt Wh What sustainable standard of living can Steve Steve af affor ord? d? How ow muc uch h shoul hould d Steve Steve save ave each each year year to to achi achieve eve that? that?

Pl Planni nning ng Method hod ES ESPlanner nner Input Inputs

ES ESPlanner nner Input Inputs Exam Exampl ple: e: $8000 $8000 of credi credit card card debt debt. Ca Calculate the he amo mortizi zing payme ment t to pay pay it off off in n 3 3 years: years: Inc Includ lude th this a s amount ount in in ES ESPlanner un under “Sp Special Expenses”: ES ESPlanner nner Re Reports 1. Housing expenses, special expenses, contributions to retirement accounts and your reserve fund, life insurance premiums, and Medicare Part B premiums. 2. All other spending. 3. Saving above and beyond contributions to retirement accounts and your reserve fund but independent of discretionary spending; amounts in red and in parentheses reference dissaving, which means using money from your regular assets, not your retirement accounts. 4. Discretionary spending per person adjusted for "two can live more cheaply" and the cost of children.

Annua Annual Sugge Suggestions ons Annua Annual Sp Spend nding ng

Annua Annual Ne Net Wor orth h Repor ort Note: e: paying off ff cred edit cards is a fo form m of f saving! Ne Net worth h peaks at retirement, spend down until age 100. 00. St Stifler’s s Mo Mom, age 55 Stifl fler er’s s Mom m is 55. . She’s s a tea eacher er ea earning $5 $51,000 per er yea ear. She e will work to age e 66, and does es not ex expec ect any salary increa ease e bey eyond in infl flat atio ion. • $300,000 of f ret etiremen ement asset ets. • Owns a house e worth $2 $220,000; she e owes es $1 $104,000 on the e mo mortgage e with 11 yea ears rema emaining, and mo monthly paymen ments of f $1 $1078; an annual proper erty taxes es are $2800, and insurance e is $8 $800. Wh What sustainable standard of living can Sti Stifl fler er’s s mo mom afford? How much should she sa save e each y ch year t r to a achi chieve t tha hat?

ES ESPlanner nner Input Inputs ES ESPlanner nner Input Inputs

ES ESPlanner nner Re Reports 1. Housing expenses, special expenses, contributions to retirement accounts and your reserve fund, life insurance premiums, and Medicare Part B premiums. 2. All other spending. 3. Saving above and beyond contributions to retirement accounts and your reserve fund but independent of discretionary spending; amounts in red and in parentheses reference dissaving, which means using money from your regular assets, not your retirement accounts. 4. Discretionary spending per person adjusted for "two can live more cheaply" and the cost of children. Annua Annual Sugge Suggestions ons

Annua Annual Sp Spend nding ng Annua Annual Ne Net Wor orth h Repor ort

Ma Married Wi With Ch Children Cons Consider der Chuck Chuck and and Lar Larry, y, a a mar arried ed coupl couple wi with 2 income mes. They plan to adopt 3 3 kids. Ea Earni rnings ngs

Home Homeow owne nershi hip Cons Consider der Chuck Chuck and and Lar Larry ow own n a a val valuabl uable e hom home e with th onl only y a a modes odest t mor ortgage. tgage. Recommenda Recommendations ons

Annua Annual Sugge Suggestions ons Di Discretionary Spending is pe per household. Li Livi ving ng Standar Standard d is per per adul adult. t. 2 2 can an live ve as as cheapl eaply y as as 1.6. 6. kids ki ds live ve as as cheapl heaply y as as about about 0. 0.4 4 adul adults ts. Consider an Inheritance Co Wh What happens if Chuck and Larry expect expect a a bi big g inher nheritance tance in n 20 20 year years?

Li Living ng St Standa ndard d Per Per Adul Adult Li Livi ving ng Standar Standard d is hi higher gher for or al all year years… s saving is reduced. Bo Borrowi wing Co Constraints… The e “eviden ence” of f borrowing co const strain raints is is th that i t it i t is not not possible e to smo mooth consump mption.

You our E Eme mergency F y Fund YO YOU NEED TO TO SELF LF-INSURE AGAINST T UNEMPLO LOYM YMENT! T! Set up an emergency or reserve fund of 6-12 months of non-discretionary expenses. You cannot afford to lose this money! • Your emergency fund must be risk-free: put it in a Certificate of Deposit , or better yet iBonds . • DO NOT use this money to buy a car, vacation, house, engagement ring, etc! Start building your emergency fund on day 1 of your first job! ES ESPLa Lanner nner “Re Reserve Fund” Suppose we tell ESPlanner that we need $18,000 in reserve fund by 2014: The recommendations suggest spending $23,937, saving $5,786 in regular assets, as well as $3600 in reserve fund in first year.

How How to o Raise Your our Li Lifetime me St Standa ndard d of of Li Living? ng? Th The e ul ulti timate ate ques questi tion on of of pe personal life- cycl cycle econ e econom omics i cs is ho how w to raise your lif lifetim ime standard of liv livin ing. . Some ideas? • invest in more Human Capital • get married • change location/housing • work longer • get a better deal from Uncle Sam Announc Announceme ment nts and nd To o Do Do Rea eadings: • STTE: E: ch ch 1, 1, 2, 3, 5, 6, 8 (t (today) Homew mework 5: Crea eate e a fi financial plan using ES ESPl Planner er (due e Tues esday 10/25) QUIZ 3 will be e on Tues esday 10/25