Tuesday, February 18, 2014

Telling Us What We Want to Hear about Our Retirement Magic Numbers

Wouldn’t it be great if we didn’t need to save so much money to have a great retirement? Well, if you don’t look too closely, David Blanchett, Head of Research at Morningstar Investment Management, can help with his paper Estimating the True Cost of Retirement.

Blanchett’s paper is very clearly written making it quite easy to follow his logic:
1. Most studies of safe retirement spending levels assume that spending increases by inflation each year (i.e., flat spending in real terms).

2. Thorough research of real spending data shows that retirees’ spending, on average, does not increase by the full amount of inflation each year.

3. A typical conclusion based on flat spending is that the maximum safe withdrawal rate is 4% at the start of retirement.

4. Using the actual spending curve for the age range 60-95, the safe withdrawal rate at the start of retirement is closer to 5%.
Isn’t this great news? If you thought you needed $2 million to retire well, Blanchett says you only need $1.6 million. However, if you see a possible flaw in the logic, I’m with you.

As long as you imagine retirees sitting beside their wheelbarrows full of cash and deciding “you know, I just don’t feel like spending as much this year as I did last year,” Blanchett’s logic seems to make sense. But what if retirees are dragged kicking and screaming into a lifestyle of lower spending by the fact that their savings are drawing down dangerously quickly? Maybe they start to spend less not because they want to, but because they have to.

Blanchett discusses this very possibility midway through Section 5 of his paper:
“What is less clear ... is whether the change in expenditures (i.e., consumption) is by choice or by need. It may be that the reason average expenditures decrease is because the average retiree did not save enough for retirement and is therefore forced to reduce consumption not out of want, but out of need.”
Blanchett then goes on to provide strong evidence that spending reductions are indeed forced. He breaks up his sample of retirees into four quadrants, high and low spending and high and low net worth. In the quadrants where both spending and net worth are matched (low-low or high-high), spending tends to drop in retirement, although more so for wealthier retirees. In the low-spending, high net worth quadrant, spending actually rises considerably faster than inflation. The high-spend, low net worth quadrant sees the biggest spending drops.

To summarize, the only quadrant of retirees who have a choice as to whether they can increase spending are the low spenders with high net worth, and they choose to spend more each year. So, a reasonable hypothesis is that the majority of people who spend less as they age do so because they are forced to rather than just wanting to spend less.

Having made this point very well, I thought Blanchett’s paper would head off in a different direction, but this section just becomes a dead end. Section 6 picks up again with the presumption that if most people spend less each year in retirement, that’s good enough for you too.

When you dream about retirement, does it include forced reductions in spending? I have little doubt that this is the fate awaiting most people, but it seems like a strange goal. I’m hoping that as I become less physically capable I’ll have more money available to give my granddaughter free use of my car in return for driving me to my poker games, or to pay my whole family’s way to a vacation with me in Aruba.

At the very least, any recommendation to spend 5% of savings in the first year of retirement should come with the following explanation. “Most people are forced to reduce their spending through retirement as their savings dwindle. I think this is good enough for you too, so go ahead and start spending 5% of your savings in the first year.”


  1. Michael, interesting critique. Notwithstanding Blanchett's paper, most of what I read and some common sense speaks to spending less as you age not because you have to, but because your ability to live the lifestyle you did when u were younger diminishes. However, as you note, I guess you can use the reduced spending for your granddaughter or your poker game.

    1. @Mark: If the spending reduction was found to happen beginning in one's 80s this would make sense to me, but it begins in people's early 60s when they are still healthy and able to travel and do other expensive things. Further, Blanchett's own paper provides convincing evidence that spending decreases because people simply don't have enough money.

      I suspect that taking my sons and grandchildren to Aruba would be where the real money gets spent.

  2. Another warning should be "Past retirees behaviour is no guarantee of future retirees inclinations."

    Many of my relatives grew up during the Depression. I'd be very surprised if their attitude towards spending is the same as the attitude of someone who retired in the past 5 years or is still working. Among other things, I've noticed these relatives are very concerned about helping their children by leaving them money--even though no money was left to them.

    Some of these older retirees are also very spending-averse. I have relatives in their 80s, for example, who hate winter but never go south during the winter despite the fact they have assets and are still saving money every year (spending less than their income) because that would be wasteful. They do travel, but only when they can drive and when hotels etc are lower priced. They also still dig out the shrubs in their foundation plantings themselves (last year), rake their own leaves and shovel their own snow. They could afford not to but their attitude is "use it or lose it."

    I think retirement planning has to be intensely tailored to the person retiring. Admittedly that makes it very difficult!

    1. @Bet Crooks: You make a good point about trying to apply one generation's retirement spending to another generation. My wife and I both have several relatives in their late 70s and 80s whose frugality would be matched by few baby boomers.