Are You Saving Too Much For Retirement?

Many index-minded investors are familiar with Scott Burns from his syndicated newspaper columns and four critically acclaimed books.

But a lot more probably know of him from his classic Couch Potato portfolios. The Burns formula of combining a few broad-based index mutual funds in a straightforward and diversified fashion is so popular that all sorts of lame imitations keep cropping up.

None of the clones has as catchy a title. And none is put together with the sort of understated sophistication that makes modern portfolio theory seem so deceptively simple.

Now Burns is turning his attention to helping families figure out just how much they really need to save to build a sufficient nest egg. In his latest book, "Spend ‘til The End," Burns and economist Laurence Kotlikoff tackle major assumptions in financial planning.

The authors refer to current methods many advisors are using to develop long-range investment goals as "rules of the dumb." As a result, Burns and Kotlikoff assert that households are setting too high of savings targets. And that in turn is creating an environment where too many investors are adopting more risk than necessary into asset allocation plans.

Besides trying to educate investors through his books and columns, Burns serves as chief investment strategist at AssetBuilder.com. He co-founded the asset management firm in 2006 after retiring from the Dallas Morning News.

On Thursday, I caught up with Burns for an update on his latest research and views on investment planning.

IndexUniverse.com (IU): Are a lot of investors really being too aggressive in their retirement planning?

Scott Burns (Burns): Yes, the conventional rule of thumb is that you've got to replace between 70%-85% of your income for retirement. Every three years, Georgia State University updates that research, which is sponsored by a large insurance company.

Burns: There are some huge reasons why that 70/85 rule is wrong. Looking at income levels during the last years of your employment [to set savings targets] ignores all of the things that have occurred in your adult life and influenced your consumption patterns. Let's start with debt. A typical household in their 30s, for example, might have commitments of about 25% of its income to debt. If you do nothing in your adult life other than to pay off your debt by retirement, that's 25% of your gross income that you don't have to replace.

Burns: Yes, and there's something else which is a major expense that you've got to take into account. It's called children. That reduces the standard of living you have as an adult. Most people very happily accept those decisions to make certain sacrifices. It looks like about 16% of your gross income goes to pay for those types of commitments.

IU: So counting children and general forms of household debt, that cuts about 40% from the conventional savings rates for retirement?

Burns: If you go to my Web site, you can find a column that looks at a couple with a single earner who makes $100,000 a year. I picked that figure for a specific reason. That covers the vast majority of the population of the United States. It uses an economies-of-scale method for figuring out the relative costs of different-sized households. It actually works fairly accurately when people examine their budgets. And this is just one tool of coming up with a figure for how much of your spending is accounted for by children. In this example, the actual spending net of all expenses is about 39% of their income.

Burns: This worker would get 24% of his wages replaced by Social Security. Workers who earn less actually get a higher percentage due to the construction of the Social Security formula. The worker's spouse (who isn't working, in this example) gets a benefit equal to one-half of the worker's benefit from Social Security. So their total benefit would be 36% of their pre-retirement income.

Burns: That's the 3% that this family in this example would need to replace from savings. The 3% represents the gap from what they've got to close from current levels of personal savings and investments. So from a quick-and-dirty calculation, the call for savings from conventional financial planners often comes up with much greater amounts than what people actually need. But this is just an illustration and not an exact calculation. Sophisticated software can come up with really precise figures.

IU: Do most planners leave out Social Security because they don't want to count on it being around in the future?

Burns: It really depends on whether a planner is a real planner or a salesman. There's a big difference. It can be argued that you should save more simply to cover for what we call public policy risk. That's the risk that Social Security might not be able to cover the income being promised. But that's another discussion. When you get right down to it, while Social Security isn't properly funded, the real elephant in the room is Medicare.

Burns: No. I've been writing and advocating low-cost, index-based investing for decades. When I decided to take a buyout from the Dallas Morning News, a business opportunity presented itself to start an investment management firm that uses these principles. I already had the building blocks for the Couch Potato portfolios. They were basically low-cost balanced funds with different allocations for different levels of risk ranging from conservative to more aggressive. We thought there was a way to add value to the Couch Potato portfolios, which were designed for simplicity.

Burns: Yes, and a good deal of them have been burned by the entire delivery system that charges them between 1.5%-2% of their money every year. We charge from 45 basis points for a $50,000 minimum account to 25 basis points for accounts of over several million dollars. Our typical account charges about 40 basis points. We figure we're a third to a quarter of what most people pay through the legacy distribution system.

IU: You're offering a broader range of risk levels than the Couch Potato portfolios, aren't you?

Burns: Three of our portfolios have less risk than the least-risky Couch Potato portfolios. On the upper end, we've also got several portfolios that take on more risk.

IU: How do you decide the risk level for people if everything's done over the Internet?

Burns: They go through a portfolio review process. Much of it's done online. We're very much oriented to the self-directed investor. If they understand their current risk level, they might want to change it. But we have a whole series of model portfolios and they select the one that best suits their needs.

We're not simply going out and buying Vanguard funds. We use Dimensional Fund Advisors funds. And we develop portfolios using mean variance optimization. We'll be the first to tell you that there are all sorts of questions about using mean variance optimization. The efficient frontier is a broad band, and we're just trying to get portfolios closer to that fuzzy band. If you do the work consistently over the years, we believe you can add some real value.

Murray Coleman is managing editor at IndexUniverse.com. He can be reached at: This e-mail address is being protected from spambots. You need JavaScript enabled to view it .