Why It’s So Hard to Spend Money in Retirement

There are many different definitions of risk in the world of finance.

Risk could be defined as the permanent loss of capital, volatility, uncertainty, drawdowns, underperforming a benchmark, missing out on opportunities, making a big mistake at the wrong time, not knowing what you’re doing and more.

For most normal people the most realistic risk is not achieving your goals.

But the true risk for many people is longevity — the risk that you run out of money before you die. This is the biggest risk in retirement for the majority of the population.

When you consider how ill-prepared most Americans are when it comes to retirement savings, it’s surprising more people don’t blow through their entire nest egg when they stop working.

In fact, the opposite is the problem for many people — they don’t spend enough in retirement.

The Employee Benefit Research Institute performed a study in 2018 looking at the spending habits of retirees during their first two decades of retirement (or less if they didn’t make it that long).

Here are the results:

  • People with less than $200k in assets (not including their house) spent down around 25% of their savings in the first 18 years of retirement.
  • Individuals with between $200k and $500k heading into retirement spent a little more than 27% of their money.
  • Retirees with $500k or more at retirement spent less than 12% of their nest egg within the first 20 years of retirement (on a median basis).
  • People with a pension spent the least from their portfolio with assets down an average of just 4% (versus a 34% decline for non-pensioners).
  • The median household in this study simply spent the income from their portfolio and avoided taking from the principal portfolio balance.

These were median numbers so there were obviously some people who did spend most or all of their savings but one-third of retirees were found to have even more money than they started with.

This seems counterintuitive but makes sense if you’re earning higher returns than your withdrawal rate.

One conclusion we can draw from these studies is many retirees simply can’t force themselves to spend down their portfolios, even those with the financial wherewithal to do so. In fact, the EBRI research showed the group with the highest level of assets had the lowest spending rates.

From a spreadsheet perspective, this makes no sense. It seems like many retirees are depriving themselves from their own wealth.

But from a psychological perspective this makes all the sense in the world.

No one lives in a Monte Carlo simulation where you get 10,000 chances at picking the path with the highest probability of success. The 4% rule sounds good in theory but reality rarely cooperates when you have a plan with zero deviations.

As Mark Watney says in The Martian, “They say no plan survives first contact with implementation.”

We all only get one chance when it comes to saving and then drawing down our retirement assets.

For most people there’s a little voice in the back of their heads telling them, “Sure, it worked out for most people in the past but what if the future is different? What if I retire at the worst possible time?”

I totally understand this sentiment. It can be a scary proposition to leave the working world behind and be forced to cover the majority of your expenses from your life savings.

You have to budget for your basic cost of living, travel, healthcare, inflation, taxes and any unexpected expenses. Plus there’s the added bonus of having no idea what future returns in the markets will look like.

It’s not easy.

This is why it’s so important to have a financial plan that takes into account the inherent uncertainty of the future.

A useful financial plan is not a document that’s set in stone. It’s a living breathing process that requires goal-setting, organization, expectations and course corrections as the plan becomes reality.

A financial plan can also help you decide how and when to spend your money effectively. There is no right or wrong answer for everyone.

The idea is you combine your current financial circumstances with your goals, set some reasonable expectations for the future and reassess along the way to account for things going better or worse than planned.

Michael and I talked about spending vs. longevity risk on this week’s Animal Spirits:

Further Reading:
What If You Retire at a Stock Market Peak?

Now here’s what I’ve been reading lately: