Have you ever walked through a busy airport, bus terminal or train station and watched how people move through the crowds? Our movement in a complex environment is incredibly impressive. We can have thousands of people rushing through a packed environment, barely missing running into each other. It is so impressive that researchers study crowd movements to help improve traffic and other systems. When placed in a crowded environment we show extreme adaptability and self-organized collective behaviors that allow us to modify our paths based on what happens next.
This adaptive approach to traffic control and movement is a great analogy to the change in approach that needs to happen to retirement planning. We need to move from a static approach, like driving down a highway, to a more adaptive approach like moving through an airport. The reason? There are too many changes, shifting environmental elements, and too many unknowns to go in a straight line from day one of retirement to day 10,950 of retirement. Retirement is not linear; our planning can’t be either.
Often, we approach retirement income planning like a math problem. We take some spend or distribution rate and test it against historical performance, adjusting the spending into the future for inflation. For instance, the 4% safe withdrawal finding takes a fixed rate of spend per year and adjusts it for inflation over time. But besides increasing the spend for inflation, the analysis does not consider changing spending dynamics over time.
In life, we don’t spend like this at all. In life and in retirement, we are not just going to take a fixed spend read and adjust it for inflation each year. Instead, real spending tends to decline through retirement, until near the end as it might start to tick back up due to medical expenses and long-term care. This creates a sort of spending smile curve in retirement for most retirees, higher in the first few years, declining over time and rising again in the later years of retirement.
If you readjust the 4% safe withdrawal rate research and instead of using a constant inflation-adjusted spend rate, you adjust for the spending smile curve of real decline in spending, the sustainable withdrawal rate goes up. According to some research by Dr. David Blanchett, it can raise the starting withdrawal rate closer to 4.73%, increasing starting spending rates by almost 20 percent. If you think about this, that is a lot more spending to start with when spending is likely providing the most utility, or happiness, per dollar of spending.
Additionally, if you look at retirement in buckets and lean into mental accounting, you can prioritize when and where to cut back on your spending even more. Research has shown that if you are willing to adjust spending for wants and needs as your retirement funding levels rise or dip, you can both improve the sustainability of your retirement income portfolio and at the same time increase the total spend over the course of retirement. Success and failure rates assume that a person is unwilling to cut back during any year for any expense in retirement, which is just not true. Instead, you can make adjustments for short periods of time to wants in order to make the plan more sustainable. Adaptive retirement income planning is a lot like diversification, it is the closest thing I have seen to a free lunch in retirement planning.
In short, this research tells an important story about the benefits of adaptability. If we can cut back spending during some time periods in retirement, we can spend more money overall. The more adaptable we become with our spending rates, the more sustainable our retirement income plan becomes. Small adjustments to spending over time allow us to spend more money early and later in retirement.
Not only does the math and science align with an adaptable based pending approach in retirement, the behavioral side of retirement also aligns. You have likely heard of the go-go years, the slow go years, and the no-go years of retirement as phases of retirement activity. When we are younger and more capable of travel and activities in retirement, we should consider spending more here as we get more enjoyment out of our spending. As we age and can no longer get as much enjoyment out of the same activities, we likely can cut back. This ties our spending both to a more sustainable approach to retirement income planning but also to a behavioral and life enjoyment approach to get the must out of our money.
This approach also moves us away from the success or failure approach of many retirement income analyses. Success or failure for retirement projections is too binary and really it is only showing us a situation when our investment assets are depleted – it does not in fact mean we failed retirement!
Instead, an adaptive-based approach focused on the potential to reduce or change spending; shifting the conversation to the risk of failure to what is the risk we will have to make to our spending plan. This is much more palatable and human first. People budget and make cutbacks all the time. In fact, any approach that suggests Americans won’t adjust spending during long-term economic downturns or high inflationary periods is ignoring historical research and behavior. Americans are resilient and we adjust during these time periods, even if we have steady income streams.
According to a Financial Planning Association Survey and Jonathon Guyton, clients who approached retirement income with a safety-first flooring approach were the most likely to cut back spending during the 2008 financial crisis. No matter what your retirement income plan is, you live in the real world and will make adjustments based on macro-economic and inflation factors. As such, our planning as professionals should account for the adaptive way people live.
Lastly, this is how we live our lives. We adjust as things change. An adaptive based retirement income plan is not a criticism of research like the 4% finding, but an enhancement to the earlier research. As our learnings and technology have improved, we can run more complex financial models and projections. This allows us to be adaptive and realize the benefits of an approach that adjusts spending over time. However, it is important to note that lower income individuals have less flexibility on average in their spending in retirement than higher income individuals. As such, everyone might not be able to cut back as much if their retirement funding levels start to drop.
Jamie P. Hopkins ESQ., LLM, MBA, CFP® is CEO, Bryn Mawr Capital Management and Director of Private Wealth Management, Bryn Mawr Trust. Jamie has extensive wealth management experience, bringing innovative thinking and will be speaking at Wealth Management Edge. Join Jamie along with 2,000 attendees senior leaders now.
