This post is a follow-up to our post of April 16, 2023. In that post, we said,
“In our ‘real world,’ lots of things can happen in the future that can affect the ratio of household assets to household spending liabilities, including variations in:
- Annual investment returns (i.e., past performance is not a guarantee of future results),
- Longevity,
- Annual inflation (or other rates of increases or decreases in household expenses),
- Spending (this is a huge source of potential variability) and spending goals,
- Sources of income (i.e., Social Security or rental income)
- Assumptions about the future
All these things make it very difficult to predict the future with any degree of accuracy.” In light of these variations, we therefore concluded that it was prudent for retirees to plan on future adjustments in their retirement plans.
In his excellent September 23, 2023 article, Planning for Spending Volatility in Retirement, T Rowe Price Thought Leadership Vice President, Sudipto Banerjee, focuses primarily on spending volatility. He says:
“Retirees are likely to experience both increases and decreases in spending levels, i.e., volatility or fluctuations, during their retirement years. By planning for and being prepared to adjust to such volatility in spending, retirees can increase their odds of success in retirement.”
Unlike many other retirement thought-leaders, Dr. Banerjee distinguishes between discretionary and non-discretionary (essential) type expenses. He concludes that most spending volatility is driven by non-discretionary expenses, and housing costs are statistically the largest contributor to spending volatility in retirement.
Dr. Banerjee points to the necessity of anticipating events in retirement that may require tapping into more liquid household assets. He says,
“Our research also shows that many retirees experience “liquidity events”—i.e., sudden large increases in spending—and need to have enough easily accessible liquid assets to meet these needs. In recent years, discussions about how to generate a steady cash flow from retirement savings have taken center stage, but in our view, not enough attention has been paid to the liquidity problem.”
Dr. Banerjee provides a nice list of household expenses in his article that may be considered as non-discretionary (essential) and discretionary. You may find his list helpful in your planning, but 1) don’t forget to consider your taxes (as discussed in our post of May 6, 2023) or any other expenses you expect to incur and 2) feel free to reclassify expenses classified by Dr. Banerjee as essential if you believe you can reduce those expenses if financially necessary (or if you may not want to fund all your essential expenses with low-risk investments—i.e., liability driven investing.)
Summary
Dr.
Banerjee warns us that, “The retirement journey spans multiple years
and there could be surprises along the way. Retirees need strategies for
both income generation and spending risk mitigation.” As discussed in
our post of September 2, 2023,
we recommend using the Actuarial Process and the Actuarial Financial
Planner each year to develop your retirement strategy and mitigate all
your retirement risks, including your spending risks.
