Retire this Retirement Rule of Thumb?

Rules of thumb when saving for retirement are somewhere between hard fact and pure guess. They often serve as a quick answer to a complicated problem.  The financial industry is replete with them: “Stocks allocation should be 100 minus your age”; “Individuals should maintain six months’ emergency reserves”; perhaps the granddaddy of all financial rules of thumb is “Your retirement income goal should equal 70-80 percent of your pre-retirement income” to maintain an existing standard of living.

Yet, is it possible that retirees don’t need 80 percent of their working income to maintain their standard of living after so much of their pre-retirement income was channeled toward saving for retirement, raising children, mortgage payments and deductions of nearly 10 percent of earned income (higher for the self-employed) for Social Security and Medicare?

All Things Considered…

Most advisors undertake a more detailed analysis of translating a client’s retirement vision into a savings and investing plan, but the broadly-accepted 70-80 percent rule of thumb among the public and financial media may have an “anchoring effect” that distorts a more realistic retirement spending requirement.

In a comprehensive analysis of consumer spending patterns undertaken by J.P. Morgan Chase, spending declines steadily from its peak (age 50-54) throughout retirement until it levels out at its low point during an individual’s 80s. This pattern remains consistent regardless of wealth.¹

In a separate analysis, this falling consumption through the course of retirement actually led to wealth increases during retirement as investment growth outpaced a retiree’s spend down rate.²

The retirement people imagine for themselves often exceeds the actual consumption experience once in retirement. Not only does an individual’s energy level decline with age, but the satisfaction they receive from big-ticket spending (e.g., a new car, exotic vacation) diminishes over time.

As Niels Bohr Observed…

“Prediction is very difficult, especially about the future.”³ Crafting a spending plan that may be 10 or more years away and over a 30-plus year period is complicated by the fact that individuals find it hard to project a future for their 70- or 75-year-old selves simply because they have no experience with being that age. We tend to create projections about spending (e.g., travel, new hobbies, etc.) based on the dreams and mindset of our 40- or 50-year-old selves.

In a world of passive investing and robo-advisors, the truly complex elements of retirement planning have not surrendered—yet—to simple questionnaires and algorithms. Building a blueprint for an individual’s retirement future still requires a skilled professional whose experiences have provided insights into the nuances and needs of the real retirement experience.

Sources:

1. https://am.jpmorgan.com/us/institutional/library/retirement-spending
2. https://www.onefpa.org/journal/Pages/FEB16-Spending-in-Retirement-Determining-the-Consumption-Gap.aspx
3. https://en.wikiquote.org/wiki/Niels_Bohr

See referenced disclosure (2) at https://blog-dev.americanportfolios.com/disclosures/