The following is “Redefining the optimal retirement income strategy,” from financial analyst journal.
Financial planning tools assume that your retirement spending will be relatively predictable and will increase each year with inflation, regardless of the performance of your investment portfolio. In practice, retirees typically have the ability to adjust their spending and adjust their portfolio withdrawals to extend the life of their portfolio. Especially if your portfolio is trending downward.
Latest Survey on Perceptions of Post-retirement Spending Flexibility It provides evidence that households are able to adjust spending and that adjustments are likely to be less dramatic than success rates and other common financial planning outcome measures suggest. It suggests that spending flexibility needs to be better built into the tools and outcome metrics we use to advise
![subscribe button](https://i0.wp.com/blogs.cfainstitute.org/investor/files/2019/01/Subscribe-Button-1.png?resize=640%2C270)
Flexible and essential expenses
Investors are often flexible with their financial goals. For example, household retirement obligations are different from defined benefit (DB) plan obligations. While DB plans carry legally mandated or “hard” debt, retirees typically have greater control over spending that could be considered “soft” to some extent. It is important when applying various institutional structures to households, such as Driven Investment (LDI).
Most financial planning tools today still rely on static modeling assumptions. William P. Bengenoriginal research. This results in the oft-cited “4% rule”. This rule assumes that spending will change only with post-retirement inflation, not with portfolio performance or other factors. The continued use of these static models may be primarily a function of their computational convenience, but also a lack of understanding of the nature of retirement obligations, or a lack of understanding that retirees may It may also be because the degree to which you adjust to your comfort level is actually comfortable.
A recent survey of 1,500 defined contribution (DC) retirement plan participants aged 50 to 70, examining investors’ perceptions of spending flexibility, found that respondents It turns out that you can cut a lot more in various post-retirement expenses than you might suggest. The sample is balanced by age and ethnicity to be representative of the target audience of the general population.
Ability to reduce various expense groups at retirement
spending group | 0% — do not want to reduce | Reduced from 1% to 24% | 25% to 50% reduction | 50% or more reduction |
food (at home) | 29% | 42% | twenty one% | 7% |
food (away from home) | 12% | 41% | twenty five% | 20% |
housing | 31% | 29% | twenty two% | 12% |
vehicle/ Transportation facilities |
13% | 46% | 26% | 13% |
holiday/ entertainment |
14% | 36% | twenty five% | 20% |
utility | 31% | 45% | 16% | 8% |
health care | 43% | 30% | 17% | 8% |
clothing | 6% | 44% | twenty five% | twenty two% |
insurance | 32% | 40% | 19% | 8% |
charity | 18% | 31% | 12% | 19% |
According to the traditional static spending model, 100% of retirees would not want to cut any of the listed expenses. In practice, however, respondents demonstrate a relatively greater ability to adjust their spending, with marked variability across both types of spending and households. For example, 43% of her respondents said they were not willing to cut back on healthcare at all, while only 6% of them said the same about clothing. In contrast, some households are more willing to cut medical costs than vacations.
The potential costs of cutting spending may not be as severe as traditional models suggest. For example, models typically treat overall retirement spending goals as essential. If the probability of success is the measure of the outcome, even a small shortfall is considered a “failure”. However, when we asked respondents how a 20% reduction in spending would affect their lifestyle, most said it would be acceptable without major adjustments.
Impact of 20% reduction in spending on retirement lifestyle
little or no impact | 9% |
Little change, nothing dramatic | 31% |
There are some changes, but it is possible | 45% |
Substantial Change and Considerable Sacrifice | 13% |
devastating and radically changing lifestyle | 2% |
For example, only 15% said reducing spending by 20% would make a ‘significant change’ or ‘devastating’ to their retirement lifestyle, while 40% said it would have ‘little or no impact’. or answered that “little change” is required. Retirees appear to be far more optimistic about the potential for spending cuts than traditional models would suggest.
A clear ability to reduce spending, as shown in the first graph, and a potential impact on retiree satisfaction or utility, at least for relatively small changes in spending, in the second graph. Being relatively small has important implications in predicting retirement income goals. While it is important to understand each retiree’s spending goals at a more granular level, how much is “essential” (i.e. “need”) and “flexible” (i.e. “want”) when planning? It is also important to know if Assets to cover retirement obligations. The following chart gives a picture of what percentage of the overall retirement income goal constitutes “need”.
Distribution of Responses: Composition of Retirement Goals Is “Required” (Required)
![Chart showing the distribution of responses: Composition of retirement goals that are “necessary” (required)](https://i1.wp.com/blogs.cfainstitute.org/investor/files/2023/01/Distribution-of-Responses-Retirement-Goal-that-is-a-Need.png?resize=640%2C397)
The average respondent said about 65% of their retiree spending is essential, but there is significant variation, with a standard deviation of 15%.
Spending flexibility is very important when considering the role of investment portfolios in funding retirement spending. Virtually all Americans receive some form of private or public pension benefit that provides a minimum level of guaranteed lifetime income and can cover necessary expenses. In contrast, portfolios can be used to fund more flexible expenses, liabilities that are very different from those implied by static spending models that suggest that the entire liability is essential. .
Conclusion
Overall, our research shows that retirement spending is much more flexible than most financial planning tools suggest. It has both ability and desire. As such, building in spending flexibility is likely to increase the level of savings required (generally lower) and asset allocation (generally more aggressive portfolios may be accepted, making certain asset classes more attractive). ) can have a significant impact on a variety of retirement-related decisions.
For more information on Dr. David Blanchett, CFA, CPA, don’t miss “Redefining the optimal retirement income strategy,” from financial analyst journal.
If you like this post don’t forget to subscribe enterprising investor.
All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect those of CFA Institute or the author’s employer.
Image credit: ©Getty Images / Paul Sutherland
Professional Learning for CFA Institute Members
Members of CFA Institute are empowered to self-determine and self-report the professional study (PL) credits earned, including: enterprising investorMembers can easily record credits using credits. Online PL Tracker.