This question, almost out of any other I discuss with clients, is the true test of a successful retirement (or any income-depending period). While much of this article is focused on the emotional and intellectual aspects of behavioral finance (Self Control and Conservatism vs. Risk Taking), the statistical approach is one that I have found specifically interesting.
Each family has their own version of spending, whether to spend all the way down and account for legacy/inheritance with Life Insurance, Real Estate and/or business ownership, or spend sparingly and leave the income generating assets themselves to family. Although those are 2 separate strategies for taking and using income from our investments, they are separated by one specific statistic, withdrawal rate.
In this chapter Meir Statman (Prof of Finance, focused on Behavioral Finance, Santa Clara University) discusses multiple types of investors/savers. Those with “High Financial Well Being” meaning they work, save and spend judiciously as opposed to “Low Financial Well Being” those who spend more than they earn, contrasted with “frugal” those who save plenty and spend little, depriving themselves, their families and the organizations they care about.
It is the frugal that identifies with “Since I retired, every withdrawal from savings has been painful”. In my experience working with people and their money for upwards of 20 years now, it is this thinking that can be the most difficult to change, because it is emotion, not logic that identifies this bias.
In several broad reaching studies in the early 2000’s, studies** show that people generally spend about half of what they could from investments in retirement, due to Loss Aversion, Mental Accounting and Familiarity Biases, all emotional/cognitive biases. The logical side of thinking says I can afford to spend this much yearly according to my plan, but the emotional side begins to calculate every bad thing that has ever happened to us and believe it would certainly (not could possibly) happen again.
Self Control Helps: NFL players are famous for their lack of self-control. Whether it is a lack of education up front on the dangers of excess, the inherent and sometimes overwhelming costs of playing in the league or the mindset a player must have to sustain a long career, ignoring obvious physical effects and injuries to believe they are invincible is not for me to say (my best bet is on the mindset option). What is known is that self control while saving can be extremely effective in how much, when and in what fashion do we save while in working years. Opposingly, this mindset can be detrimental to spending down the investments we worked so hard to accumulate.
We Spend Less as we age: Concern about running out of money is the primary reason we hold fast our assets in early retirement; however it is not the only reason over a long retirement period. There are 3 facts that play here and can be difficult to stomach.
- We Spend less as we age: At around the age of 80 is when many of us lose the enthusiasm for traveling. While discretionary spending declines, healthcare spending rises, that while spending on movies, theater, opera and concerts declines by 50% from age 62 to 84, spending on things like hearing aids, nursing homes and funerals increase by 50%.**
- We die sooner than we hope: Social security tables estimate that only 1 in 10 current 65-year-olds will make it to 95. Although most clients plan for at least a 30-year retirement income need. **
- We believe it is better to leave an inheritance than give a gift. Many feel preserving capital for the next generation is important, but that raises the question, all else being equal; Why not give with a warm hand, rather than a cold one? Of course, family dynamics must be accounted for and spendthrift children may make the imposition of sudden wealth difficult to stomach, but the fact remains, you cannot take it with you.
A couple interesting facts to end this discussion. These are taken from an article in the Investment and Wealth Monitor. 2023.
- People who own Long Term Care Insurance, on average, spend 33% more in retirement. **
- Only 34% of Individuals ages 65-74 are spending more than their income and depleting savings. **
- Retirees are more likely to reduce discretionary spending (73%) or adjust their budgets (67%) than draw down money from their savings or nest egg (38%)*
- Retirees in the top quartile of financial wealth spend nowhere near an amount that would put them in danger of depleting their portfolios during a 30 year retirement period.*
If I can be of any service, even as a 2nd opinion or sounding board, please contact.
References
- *Meir Statman, Finance for Normal People (New York: Oxford University Press, 2017)
- **Todd Taylor, FSA and Kelli Faust FSA, MAAA; Understanding Underspending in Retirement, Investments & Wealth Monitor December 2023