It seems like every article we read these days says that people are not saving enough for retirement. Wouldn’t it be great to find out that you may be overestimating how much money you need to retire? Don’t get me wrong. The more you save, the better, and we certainly want to err on the side of generosity when estimating retirement expenses. That being said, a growing body of research shows that the average retiree experiences a decline in real spending as he or she goes through retirement.
At the risk of oversimplifying this…if you look at an average retirement (avg. retirement is 22 years) the amount of goods and services purchased falls by almost 2% per year. The inflation rate over the past 50 years has been roughly 3% per year. So total spending grows by about 1% nominal terms. You would significantly overestimate the amount needed to retire if you assumed that all of your spending was going to grow at 3% per year for 20-30 years.
You may be thinking, “But wait a minute…how are my expenses going to decrease when I want to remodel my house, travel, and buy a boat?” Well, everyone’s retirement is different. Prolific travelers, retirees who own multiple houses, or those who make big purchases may have a different experience, which is why each plan needs to be customized to your particular goals and spending habits. However, the book The Prosperous Retirement indicates that most retirees go through three phases: The Go-Go Years, The Slow-Go Years, and the No-Go Years. Spending drops for the average retiree in all three phases. It drops the least in the first phase of retirement when retirees are the most active. Spending drops the most in the middle of retirement, and then it continues to drop, but at a more modest pace in the final phase of retirement due to an uptick in healthcare costs.
I was working on a retirement plan for a client this past week and comparing different scenarios. The amount of spending forecasted 21 years from now was $177k when we used a 2.5% inflation rate vs $141k with a 1% inflation rate. This client’s plan was significantly more likely to succeed with a forecasted 1% inflation rate for retirement expenses, even when we added an additional $6k travel budget each year for the first 10 years of retirement.
Naturally, all of the figures herein and the concept of spending increases are based on averages. You know what I always say about averages: If one foot is in boiling water and the other is in ice water, on average you should be comfortable. So, proceed with caution. Have a great week and email back with thoughts or comments.