How much can one spend without risking insolvency? That is an important question, but the so-called “4 percent rule” has been dissected so many times and from so many angles, planners can be forgiven if they are sick of safe withdrawal rate research.
Despite being a bit of a research junkie, I also can’t say I get particularly enthusiastic with each new paper either.
One of the more substantial hang-ups that I have with withdrawal rate research centers around the spending assumption. I have been advising retirees for over a quarter-century, and I have yet to find a single household that actually spends money the way typical withdrawal rate research assumes. Studies assume a specific amount is spent in year one of retirement and that amount is increased in lockstep with inflation each and every year.
I recognize that many retired Americans that live solely on Social Security and/or some pensions spend in a similar pattern to that used in these studies, but that is a circumstance in which they have no choice because they have no assets to generate additional income.
My clients have some assets to supplement these sources and none of them spend using such a pattern.
Because of this disconnect from the spending pattern illustrated and what families really do, I find much of the research almost useless. I find myself wanting to see more research that could enlighten as to whether what I observe anecdotally among my clients is common or anomalous.
Most of my clients have the assets that they do because they learned to live within their means and spend less than they made. This discipline seems to have carried over into their retirement in that they usually start spending an amount they know will cover their typical ongoing expenses and provide some degree of cushion.
What I see most often is that clients do not increase their regular withdrawals for several years after they retire. As their expenses increase with inflation, the cushion shrinks, but it takes a few years for that cushion to shrink so much that clients want an increase.
I would love to see substantive research on this but for now, you will have to settle for my theories as to what contributes to this phenomenon.
I like to think that because we spend time educating clients and discussing the interplay between their spending levels and the behavior of their portfolio, clients better understand the consequences of their spending choices. Many clients have indicated that is the case.
They learn that families with lower fixed expenses have a greater ability to spend more early in retirement when they are typically healthiest and most able to use their money for active pursuits. Another way to put this is families that are spending because they want to are better positioned to handle the vagaries of financial markets than families who are spending because they have to.
Our clients already knew intuitively that the less they spend, the longer the money will last, but the process helps them frame the issue and have more confidence about what they can spend. They know they are choosing to spend and could choose to spend a bit less during tough times.
They have tightened up a bit their whole lives whenever conditions were challenging. When a potential layoff loomed, for instance, they didn’t like it, but they did not just continue on spending as they had. They adjusted and that is one reason they have the accumulation of assets they do.
Because of their spending discipline and the natural understanding that lower expenses make assets last longer, clients seem predisposed to resist inflation increases.
They often curtail spending over time without me suggesting it or market volatility motivating them to do so. For example, when they look to book a vacation, the cost may have gone up from when they first retired. They may stay at the JW Marriott instead of the Ritz Carlton. Not the same but still very nice. The effect of inflation causes them to make that choice rather than increase their withdrawals.
Travel, recreation and entertainment are probably the three areas I see this gradual scaling back most often. The reduction of these expenses seems to accelerate as people age and from what I can see, the decrease is far more often a function of slowing down not one of financial necessity.
Look around your local country club and you will probably see some golfers in their 80s and 90s, but you won’t see many. Check the bulletin board, and you may notice the average age of those selling clubs, carts and even memberships is older than the average age of club members generally.
There is some research and other information that describes what retirees spend.
One source of information is the Bureau of Labor Statistics (BLS). In 2005, the Journal of Financial Planning published a paper by Ty Bernicke, CFP, that used data from the 2004 Consumer Expenditure Survey to posit that spending decreases with age. Bernicke referenced the same BLS survey performed in 1984. He adjusted the spending data for inflation and the ages of the cohorts and found the spending to be significantly less than what would have been illustrated by the typical 4 percent rule methodology.
Recently, I saw a JP Morgan slide using numbers from the 2014 survey. Again, spending on basic household expenses decrease over time in most categories with health care, charitable contributions and gifts being notable exceptions. The use of the data by JP Morgan and Bernicke differ but the typical decrease described from the under age 75 set to 75+ was about 25 percent. This is despite, as JP Morgan noted, the fact that CPI-E, an experimental inflation measure from BLS for persons over 62, has run higher than headline CPI and CPI-W, the inflation measure used to adjust Social Security.
A more robust look at the issue came from David Blanchett, CFP, CFA, in “Exploring the Retirement Consumption Puzzle” (JFP 2014). Blanchett took his analysis to a different level and dove deeper into spending and net worth.
Most headlines I saw noted the spending “smile” Blanchett observed in which spending decreases for a time until the latter years when it increases largely due to health care costs. What the headlines skipped is that the smile is not such that the rise in later years always brings total spending up to where it once was. Despite the increase, total spending is still typically lower for the elderly than new retirees.
Blanchett's examination of the interplay between spending and net worth jibed with both Bernicke’s contention and my observation that the decrease in spending at advanced ages is largely a reduction due to a less active and expensive lifestyle, not one driven by financial need. The increase in gifting would support that dynamic. The clearest exception was households that were deemed underfunded from day one of retirement.
Can financial planners use theory to enhance practice? I think so. It takes a good conversation.
I like to talk with clients about their savings history first. I ask them to describe a difficult time they had financially and what they did. This helps them recognize that they have adjusted to conditions in the past. Cutting back due to conditions out of one’s control is not what anyone wants when they retire but if they were successful adapting before, and are prepared with the knowledge of what that might look like for them specifically in the future, they become better able to move forward with confidence.
I then typically share the highlights of research and anonymous stories of spending changes from other clients. This has led to some terrific conversations about how they see their retirement spending evolving, how to generate the cash flow needed to support their vision and how to absorb the inevitable “off budget” expenses that arise.
Research has helped answer several important questions like “How do retirees spend in general?” It has also helped me get a better answer to “How will Mr. & Mrs. Client spend?” As a practitioner, that is what matters most.
Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager and Worth magazines. He practices in Melbourne, Fla. You can reach him at www.moisandfitzgerald.com.