Friday, July 15, 2016

Don’t Let Financial Fears Ruin Your Retirement

Recent research has shown that some retirees may be underspending their assets in retirement.   In their article, “Spending in Retirement: Determining the Consumption Gap”, Researchers Browning, Guo, Cheng and Finke noted, “retirees seem to spend much less than theory would predict.  Rather than spending down savings during retirement, many studies have found that the value of retirees’ financial assets hold steady or even increase over time.”  These researchers refer to this phenomenon as “the Consumption Gap.”  The Society of Actuaries “2015 Risks and Process Survey” report that I discussed in my previous post noted a similar trend.   In this post, I will outline how the Actuarial Approach discussed in this website can address this issue for retirees who may not be happy with their current spending levels.
With respect to this consumption gap, Browning et al speculate that “Fear, failure to plan, and a lack of confidence in pre-determined drawdown strategies may be significant contributors to the conservative consumption observed among retirees,” and “Feelings of inadequate preparation may shift retirees’ mindsets from decumulation to preservation.”  Figure 1 of the Society of Actuaries’ report notes the following top five significant concerns expressed by surveyed retirees (percentage indicating very or somewhat concerned by the item).

  • You might not have enough money to pay for a long stay in a nursing home or a long period of nursing home care at home (58%) 
  • The value of your savings and investments might not keep up with inflation (52%) 
  • There might come a time when you (and your spouse/partner) are incapable of managing your finances (48%) 
  • You might not have money to pay for adequate health care (47%) 
  • You might not be able to maintain a reasonable standard of living for the rest of your life (45%)
As I have previously said, the purpose of this blog is to help retirees (and their financial advisors) develop reasonable spending budgets.  I’m not here to tell you how much you should actually spend each year.  If you want to spend less than your actuarial spending budget each year and grow (or preserve) your assets in retirement, that is fine with me.  If these are your goals in retirement, far be it for me to tell you that your goals are wrong.

If, on the other hand, your underspending in retirement is driven by the concerns/fears summarized in the Society of Actuaries survey above (or some other fears) and you would spend more if you were convinced you could afford to do so, then this is where the Actuarial Budget Calculator may be helpful to you.   Unlike most rule of thumb asset withdrawal strategies (like the 4% Rule or other Safe Withdrawal Rate approaches) that are mathematically designed to have an x% probability of not running out of money over a given period of time as long as assets are invested in a certain manner, historical returns are achieved in the future and exactly $Y real dollars are withdrawn each year, the Actuarial Budget Calculator enables you to match your liabilities with your assets, using your best estimates of future experience (or conservative estimates if you prefer) regarding the economy, your investment returns,  your expected period of retirement, your future essential and discretionary expenses, etc.   Thus, rather than simply worry about whether you will have enough money to pay your expected long-term care costs, make reasonable assumptions about when and how much those costs might be and set aside funds today to cover those expected costs.  We discussed how you might do this in our post of January 12th of this year.  Similarly, you know that you will have unexpected future expenses that will not be covered by your annual x% withdrawal, such as home repairs or a new car.  Don’t simply worry about how those expenses will be paid; make reasonable assumptions about when and how much these costs might be in the future and set aside funds today to cover these costs.

The Budget by Expense tab of the Actuarial Budget Calculator allows you to develop a comprehensive spending budget that can cover all your future expected and unexpected expenses as well as your desired bequest motive.   You can be as conservative as you like in developing your total spending budget.  And, as discussed in the last post, you can even set up a Rainy Day Fund to mitigate future investment losses.   After making reasonable assumptions and developing a reasonable spending budget, you just might find that you can spend more today than you think.  And even if you can’t increase your current spending, you might be able to increase it in the future if the assumptions you made about the future turn out to be too conservative.  Unless your goals include growing your assets, you need to find the appropriate balance between spending too little and not spending enough.  As we discussed in our post of October 12, 2015, it is important not to let fear unduly influence this task.

I agree with Browning et al when they specifically point to a lack of confidence in popular draw-down strategies as a significant contributor toward underspending by retirees.  I also agree with the authors’ statement that, “Retirement income conversations may need to move away from sustainable withdrawal rates toward strategies that maximize spending for a given level of financial assets, while addressing client concerns about uncertainties.”  This is exactly what you can do with the Actuarial Approach.  It can provide you with the information and knowledge you need reduce your stress and help you get past these fears.