For those of us in Northeastern Ohio who are even casual sports fans, the 2015 playoffs and now the NBA Finals has been a gut-wrenching roller coaster ride. For me, watching our Cavaliers play has consisted of three hours of pacing, hand-wringing and standing-with-arms-crossed in front of the TV. But I am a little older (and maybe a little wiser) than my younger days and one thought has kept me from pulling out the remainder of my hair. That thought? I’m not playing or coaching (thankfully for all of us) so I have no control on the outcome of the game…..so I shouldn’t get too worked up. Whether they win or lose, it’s not a life-changing event for me and my family.
Of course, thoughts like that inevitably leak into my vocation as an independent financial advisor. And the analogy to our financial lives comes down to one simple statement: Control what we can control. As I’ve noted in prior posts, we can’t control interest rates, stock market returns, Fed policy or global economic trends. Given that fact, we should plan for scenarios that assume changes to all these variables. However, what remains most important is that we control what we can control.
While there are many factors we can control in our lives (effort in our career & education, asset allocation, etc.) I want to focus on one factor that I believe has an ENORMOUS and underrated impact on the success of our retirement strategy. That factor? Spending. To illustrate, I’ve assembled three cases that demonstrate the impact of two different levels of spending and two different levels of “inflation adjustment” (annual increases in spending). The results are still shocking to me, even though I’ve run these scenarios for clients many times.
So here are the facts that apply to all three cases that apply to our sample client – Joe & Mary Client. The “variable” that we are isolating here will the last one – Living Expenses (currently and in retirement) and annual increases in this expense.
- Age 52 / Retire at age 65 / Death at 90
- Current net worth: $1.3 million / current value investments: $941,000
- Current Pre-Tax Income: $190,000
- Income in retirement: $63,000 (social security and $12,000 pension)
- Living Expenses: $120,000 currently and in retirement, GROWING at 3.7% (about average historical inflation
(There are also other variables considered but I’m trying to keep it simple)
Below is an estimate of lifetime cash flow graph showing the value of investments using all these variables (and many more):
Base CASE #1 – Investments value with Living Expenses in retirement $120,000, indexed for inflation 3.7%
Key Takeaway: They could run out of money near Age 90. Chance of Success (not running out of money): 36%*
Now I will change ONE Factor: I will reduce living expenses to $100,000 / year (from $120,000 / year) in retirement only- meaning the will continue to spend $120,000 until age 65 (retirement age) and then reduce their living expenses to $100,000 per year.
Base CASE #2 – Investment value with Living Expenses in retirement reduced to $100,000 from $120,000, indexed for inflation 3.7%
Key Takeaway: They will likely NOT run out of money. Chance of Success (not running out of money): 76%*
Now I will change one more factor: I will keep living expenses at $100,000 / year (from $120,000 / year) in retirement and ONLY increase spending each year by 2% (not 3.7%).
Base CASE #3 – Investment value with Living Expenses in retirement reduced to $100,000 from $120,000, indexed for inflation 2.0%
Key Takeaway: They will almost certainly NOT run out of money. Chance of Success (not running out of money): 100%*
Here’s the bottom line: We can only control what we can control and one of the most critical variables under our control is our spending. Extrapolating out the spending variable over multiple decades has a substantial effect on people’s peace-of-mind before and during retirement. So just like none of us will need to hit two critical free throws with 10 seconds left in a game, (unless you’re Matthew Delladedova – if you are, we should talk) we can’t control the stock or bond market. But we can control how much we spend. This is why this analysis is done every year with clients before retirement and in retirement so we can (pardon the pun) keep our “eye on the ball”.
(* Note: The “Chance of Success” is estimated by running a monte carlo simulation with 1,000 cases.)