Published On: August 21, 2018

Written by: Ben Atwater and Matt Malick

For financial advisors, spending can be a taboo topic.  However, through much experience with retirement income projections, we’ve learned that spending is, by far, the most important variable for a successful retirement plan.

For example, a client spending $250,000 per year in retirement might need in excess of $6 million in assets to retire, while a client spending $50,000 per year in retirement might need significantly less than $1 million.

Obviously, every situation is unique and these generalizations depend on a number of factors, among them Social Security, pensions, deferred compensation, inheritances, Medicare, etc.  It is important that everyone establishes a retirement plan that is distinct to their needs.

An actual client example using our Wealth Management software, Money Guide Pro, further illustrates this point.  The client we’re highlighting plans to retire in about three and a half years, has about $1 million invested in balanced portfolios and is entitled to $53,000 per year in Social Security benefits (all in today’s dollars).  Using a Monte Carlo analysis, a statistical process of evaluating the probability of different outcomes, the below table illustrates the client’s probabilities of success at various levels of spending:

Spending before retirement sets the tone for the second most important aspect of retirement planning, the size of your retirement nest egg.  Obviously, the less you spend during your working years, the more savings you will have for retirement, all things being equal.

Spending, whether during retirement or before, is an incredibly broad subject, so we’d like to focus on some of the mistakes we see, as well as some ideas for setting-up a successful spending equation.

Common Mistakes

  • Buying personal real estate. After receiving or accumulating a large sum of money, people often feel compelled to significantly upgrade their primary residence or purchase a second home.  Although this is sometimes prudent, it is worth serious consideration, including a detailed cost / benefit analysis as to how this purchase will impact your retirement projections.  This analysis must include realistic carrying costs for the real estate in question as well as a thorough understanding of the liquidity constraints inherent in the real estate.
  • Investing in or starting a business. It is common for people to decide they want to invest money in a business or to start their own business.  Understanding the true costs of a business venture, whether in terms of time or money, can be eye opening.  Furthermore, grasping the time it takes for a new business to become cash flow positive is vital.  More generally, people tend to justify certain spending as an “investment.”   When purchasing something for pleasure, you need to at least question its investment merits.
  • Helping the kids. Its admirable and often necessary to help children, but when you have some discretion, you must examine if you can actually afford to help.  Tuition expenses are a great example.  Quite simply, many people can’t afford to spend $500,000 putting two children through college.  Students can often borrow for college, but parents can’t borrow for retirement.  Banks don’t offer retirement loans, but they do offer student loans.

Tips for Successful Spending

  • Have a budget. Creating a family budget is a useful strategy.  Short of having a budget, at least keep careful track of where your money goes.  Most people we talk with tend to underestimate their spending.  And, whether as part of a budget or not, pay yourself first.  In other words, set-up automated transfers to savings from paychecks, deposit accounts, inheritances, etc.  Make sure you have a disciplined savings program that works automatically to put money aside before you spend.
  • Test large purchases against your retirement plan. Before pulling the trigger with any large expenditure (even an “investment”), scenario-test the cash outflow against your larger retirement plan.  Understand the true cost of an expenditure, not just its price tag.  We are here to help you do this.
  • Avoid the comparison trap. Don’t worry about what others have.  If everyone in your group has a vacation home, who cares?  Rarely do you know how well others are doing with their savings; don’t confuse bling with bucks.

Just as there is an enormous difference in the amount of retirement savings you need based on your spending level, like the $250,000 versus the $50,000 example we cited above, saving for retirement entails similar mathematical realities.  If you save $20,000 a year for 45 years and earn an average of 5% per year, you’ll accumulate $3.2 million, but if you save $30,000 under identical circumstances you’ll accumulate $4.8 million.

Although we write a lot about investing, the heart and soul of retirement planning is spending and saving.


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