People have many different views on how they will spend their “golden years” once they’ve left the workforce. Some envision a lifestyle filled with travel, adventure, and leisure, whereas others just want to have more time to spend at home, with maybe an occasional visit from the grand kids. Some dream of owning a boat, a vacation home, and a timeshare, while others just want to unload the stressful job they feel tethered to.
In our experience in working with clients, the best starting point for planning for your future lifestyle is by looking at your current expenses. While you do occasionally find a retiree who is willing to completely sacrifice his or her current standard of living just to quit work, rarely do they seem truly satisfied thereafter. After all, research shows that our personalities, preferences, and values change less and less as we age, and you’re unlikely to be happy if you have plenty of time, but no money to live the lifestyle you want.
And while traditional financial planning has often taught us to expect to spend 80-90% of our pre-retirement income, we have not seen this to be true (at least for clients with means who want to enjoy the wealth that they have so carefully built.) While on the one hand it does make intuitive sense that some pre-retirement expenses will indeed disappear (such as dry-cleaning, commuting, and workplace lunches), many new ones will probably surface, if for no other reason than you now have more time to do things you enjoy. In fact, our experience is that, if anything, costs tend to go up for the first few years of retirement (while people have the time and resources to pursue their passions and long-delayed dreams.)
However, at some point (and that point is different for every person), it is typically health-related concerns that cause spending to begin to go down. Whether it be physically or mentally “slowing down,” the end result is that people often reach a point in life where they just don’t feel like taking exotic vacations or living a “go-go” lifestyle to which they were once accustomed. Now, new research is coming to light that sheds additional insight (and empirical data) on the situation. As it turns out, our clients are not unique in this regard, costs on average do tend to go down slowly over time in retirement, but typically not at first.
Retiree Living Expenses Typically Go Down Over Time (Eventually)
New research has been published in the last decade on retiree spending trends that shows spending tends to decrease in retirement over time, when adjusted for inflation. For instance, one early example of this research would be a 2005 article published in the Journal for Financial Planning. In this paper, Ty Bernicke, CFP reveals his research done on decades of Consumer Expenditure Survey data, which showed that real (e.g. inflation-adjusted) costs in retirement tend to drop by 15% every five years, on average. Running the math, that means that in 20 years the cumulative effect would be that those in their late 70s are spending less than half of those in their late 50s.
To us, that finding seems overly optimistic. (Optimistic in the sense of spending less means your money lasts longer.) Indeed significant criticism of this data emerged, and subsequent studies were done to further test those findings. For example, the Boston College’s Center for Retirement Research published a study that reported a similar, if less pronounced, trend. Their report showed an inflation-adjusted 1% drop in expenses per year, even after adjusting for other factors.
Both of these studies relied on the Bureau of Labor Statistic’s data on consumer expenditures (the CES survey), just sorted and organized slightly differently. But what about data-sets outside of government sources, do they show anything different? Surprisingly, no. Morningstar did research on the Rand Health and Retirement Study (HRS) and JP Morgan conducted its own review of private credit and debit card data, both with similar results. The bottom line is that while spending for the typical retiree will probably start out similar to his or her pre-retirement budget, it will most likely decline in inflation-adjusted terms as time goes on.
When You Retire Plays an Important Role in Spending
From our experience when you retire is one of the most important factors. Those retiring early in their 50s often find that lifestyle expenses stay the same or even increase, at least for the first decade or so of retirement. The gradual decline often comes later, after they have taken the dream vacations and crossed a few things off the old bucket list. On the other hand, those retiring in their late 60s or even 70s often see their expenses drop more immediately.
The JP Morgan Chase study is interesting in this respect, because it accounts for the trends of both “mass affluent” households (with $1-5 million) and starts in the mid-40s. It finds essentially no drop, on average, in spending during the first few years of retirement. However, over time spending does go down as shown in previous studies.
Additionally, the Chase study breaks out the spending patterns into four distinct profiles, which they determined were statistically similar: foodies, homebodies, globetrotters, and health-care spenders. Without diving into the details of each group, the fact that such distinct patterns emerged reveals the wide range of spending patterns that people have. Each household is different, which is why we start with your current spending level when planning for retirement, and then adjust as we get to know you.
Why Your Spending Level Matters to Long-Term Retirement Success
It matters because there are two factors making saving for retirement even more difficult in today’s world. First, because medical improvements and higher standards of living have translated into longer and longer lifespans in the developed world, saving for a 30-40 year retirement requires a serious amount of capital. Second, our current economic environment of low interest rates means that traditionally “safe” investment products, such as government and high-quality corporate bonds, often don’t pay enough interest to fund retirees’ spending needs. These low interest rates translate into lower returns on traditional investment portfolios over the short term, and therefore potentially means higher portfolio values are needed before retirement, all else being equal.
(As an aside, if we have learned anything from history, we can probably assume that “this too shall pass.” Trends come and go in the investment world, and projecting current market conditions out over a 30-40 year life expectancy is obviously a bad idea.)
Yet we can take some of the stress out of the situation by recognizing that there is some probability that expenses will decrease over time in retirement, on an inflation-adjusted basis. If we have less aggregate spending in retirement, then obviously we need less capital up front. (Maybe that means clients can save less or retire earlier than expected?) In addition, if the client has significant pension and Social Security income to rely upon, his or her withdraws from investment assets may go down significantly over the years, assuming the pension and Social Security income streams rise with inflation.
The Challenge With Estimating Your Future
Again, the wrinkle with all of this is, of course, that while statistics tell a story that may be helpful for having educated discussions around these topics, they tell us nothing about your individual situation. Our clients aren’t statistical averages, they are real people with individual goals, plans, and circumstances. Knowing that the average spending level potentially goes down over time tells us nothing about what their individual experience will be.
So what’s the answer to this from a planning perspective?
We get to know our clients.
Only by building a relationship over time can we help clients make these difficult decisions. At the end of the day, statistics can’t tell us the future, they can only tell a story about trends in the past. Individual people have to make individual, real world decisions about when to retire, what retirement budget to set, and when to break or not break that budget. And we can help you make those decisions by giving you both the knowledge and the process to weigh those decisions within a reasonable framework, so that you can feel comfortable and confident in retirement. That’s part of the value of working a competent and experienced Personal CFO.