In a recent Reuters article, Linda Stern explains that there is a big difference between an ideal retirement and the kind of retirement people end up with. She’s right about this. But she goes off the rails when she suggests that you should plan for a typical retirement.
Apparently, “Most people spend a lot in their first year or two of retirement ... But over time, retiree spending drops substantially.” It’s hardly surprising that people spend now and worry about the consequences later.
But when Stern advises that retirees plan to “start their retirements withdrawing 5 percent or more of assets in their first year of retirement” because retirees “don't inflate their spending on an annual basis to match the Consumer Price Index,” she goes off the rails.
I find this logic nuts. Other people plan poorly, overspend initially, and endure the painful reality that they’ve wasted a chunk of their savings and have to cut way back. So, I should set out to do the same thing?
Thanks, but no thanks. I’m going to try to avoid any painful cutbacks. I may not succeed, but I’m not going to throw in the towel right away.
Also basically ignores the research around retirement portfolio risk arising from the sequence of returns. That is to say, it's one thing to withdraw 5% a year for the first few years of retirement if your portfolio is returning 10%, another thing altogether to do that when your portfolio returns are negative. In the former instance, you're probably ok, in the latter, you may be significantly increasing the odds you'll run out of money.
ReplyDelete@Juan: You're absolutely right that the sequence of returns risk is important. However, instead of running out of money, Stern says you'll just reduce spending so that you won't run out of money. This doesn't seen very appealing to me, though. I'd rather start my retirement spending a more realistic amount.
DeleteAnother issue is that we're not really sure why the typical pattern exists. Do people spend a little more in the first few years on travel and the like because they're taking advantage of their time flexibility while they're still mobile? Or is it actually that they spend less because after a couple of years of overdoing the withdrawals they suddenly realize that they're going to run out of money? One of these patterns is mindful, one less so.
ReplyDelete@Anonymous: No doubt there is some of both averaged into the data. I find the case of overdoing withdrawals more plausible for relatively young retirees (under 70).
DeleteCheck this out * Aguiar, M. and Hurst, E. (2013) “Deconstructing Life Cycle Expenditure” Journal of Political Economy, Vol. 121, No. 3, pp. 437-492 on http://scholar.princeton.edu/maguiar/files/670740.pdf and interpreted n the Economist http://www.economist.com/blogs/freeexchange/2013/08/ageing-and-personal-finance
ReplyDeleteDropping spending in retirement isn't a reflection of being poorer in dollars.
@CanadianInvestor: The authors of the study you cite make a compelling case that people want to spend more in their 40s than they do in retirement. I don't dispute this; it makes sense to me that there would be a fairly significant drop in spending from working to not working. The rule of thumb that you need only 70% of your pre-retirement income may not be exactly right for everyone, but it's not far off for most.
DeleteHowever, none of this is relevant to the question of why spending declines during retirement. It makes sense that some buy a boat or RV in their first retirement year. But why does spending decline from the 2nd to 3rd year? And a again from the 3rd to 4th year, and again every year after that? The most plausible reason is that some people start to run out of money. By the time people get into their 80s I can see spending dropping because many people just don't want to go out, but it makes no sense for this to begin voluntarily in one's 60s.
Let's leave the world of population averages for a minute. Do you want a retirement for yourself that has forced reductions in spending by a few percent each year? This is what many financial planners would have you do in order to give you a higher starting spending level. If that works for you, that's great. I prefer to save a little more and count on wanting the same level of spending across at least my first decade of retirement. I may even need to increase spending to keep up activities when I get to my 80s.