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Retirement spending looks different for everyone

Have you seen the commercial that asks viewers, “What’s your number?” It has people walking around in their everyday lives carrying a huge orange number, their retirement nest egg number, which varies wildly from person to person. The commercial is effective because it makes people think about their financial future. Since it’s only 30 seconds, it necessarily leaves out much of the nuance that goes into figuring out how to calculate that number, which is why I think it misses a bigger point. I often bring it up in client meetings, so we can explore how we get to a number and what it really means.

What I often find is that people really need a place to start when thinking about spending in retirement. Talking about finances and spending is deeply personal, so many people have no frame of reference to compare their spending against anything else. Luckily, there are some good sources of information that shed some light on retirement spending. Real spending, by that I mean spending adjusted for inflation, declines as people age. Spending is usually highest in the early years of retirement. Things like travel, dining out, or a second home in a warmer climate tend to rank high on the priority lists of many people. However, as time goes on, travel becomes more local and dinners out less frequent. You can see this manifest itself around town as groups of retirees convene in Safeway, McDonald’s, or local coffee shops. It becomes less about doing things and more about relationships with others. The graph below from JPMorgan Chase shows this trend in much more detail.

As people near retirement they have less time to change their financial habits and circumstances, so that number, their nest egg, is relatively fixed.

People often struggle to quantify what they currently spend and where they spend it. Add in the fact that life is anything but predictable and it’s easy to see why finding the right number becomes such a challenge. What most people want to know is: how much they can safely spend while enjoying their retirement? This is no small order. William Sharpe, Professor of Finance, Emeritus at Stanford and winner of the 1990 Nobel Prize in Economics calls it “the nastiest problem in finance.”

We take this into account when helping clients plan for their retirement. But it still doesn’t answer the question of “How much can I spend?” Nearly every client I’ve worked with has questions rooted in their fear of running out of money. The fear of having to go back to work, to rely on family, or just not living the lifestyle they are accustomed to is real. In fact, it is the largest obstacle to overcome before people free themselves up to think about things they’d really like to do. It’s Maslow’s “hierarchy of needs” at work.

If a Nobel Prize winner deems retirement spending the hardest problem in finance, I can’t hope to provide you with an exact number for how much you can spend in retirement. What I can do is help you start thinking through the issues in the right way.

One way to begin is by sitting down and using the chart above as a starting point to approximate what you are currently spending and how that will evolve with time. This practice will go a long way toward understanding the most important variables in your retirement plan. The second thing to do is to review and understand your guaranteed sources of income; things like social security and pensions. Both social security and pensions have a myriad of options that are outside of the scope of this article, so if you aren’t confident in choosing the best option, be sure to get advice on the best way to approach thinking through both.

Finally, after figuring out how much of your lifestyle is funded by these sources, you can begin to construct an investment portfolio that provides you with the best odds of successfully outliving your resources. If you remember the illustration from my last article, where the portfolio with the higher average return resulted in less money at the end of 10 years. Said another way, it isn’t necessarily the portfolio with the highest return that will give you the best outcome. It’s only after accounting for your personal situation that you can come up with not only “your number,” but also the portfolio that helps you to maximize your chances of having a successful and happy retirement.