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Imagine that your retirement lasts for 30 years. On average, in two-thirds of scenarios, you’re more likely to finish with quintuple your starting wealth than to finish with less than your starting wealth. I’m guessing you’ve never heard that stat mentioned in any articles you’ve read about money management in retirement.
Welcome back to Financially Well, the finance podcast for Millennials. I don’t know about you – and, please, shoot me an e-mail to tell me – but I feel like almost everything we read about retirement is negative.
Now, I’m not surprised, for two primary reasons. First, according to the Aspen Institute, as of 2019, 10.4% of U.S. households (or about 13 million people) had a negative net worth. And the median net worth in 2019 across all ages was less than $122,000. Many Americans truly face a current or future retirement crisis, in which they may need to work much longer than they would like or are able.
There’s also a second reason why I believe we only hear retirement-related fearmongering. Retirement, specifically financial planning for that stage of life, is full of uncertainty. Most Financially Well listeners (and its host) have decades until we retire. So we may not know yet what we want retirement to look like. We also may not want to prioritize saving for such a distant purpose right now. So, many institutions, such as the government and maybe your parents, resort to creating as much fear a lot of fear around your money management in retirement. Rather than emphasizing the freedom and opportunities that investing for your future may create, they essentially try to scare you into saving.
Today, I want to offer an alternative perspective. I want to give you a break from worrying about retirement for once. Now, I want to say upfront that the data on which I’ll focus won’t apply to everyone’s unique circumstances. But almost all Millennials share one common trait: we still have the benefit of time when it comes to investing. Even if you don’t have much invested in retirement accounts right now, you’re young enough to still take advantage of compounding growth in the stock market.
But, at some point in the future, no matter the specific dollar amounts that pertain to your life, you’ll need to take a leap of faith. You’ll need to trust that you have enough saved for retirement. You’ll need to feel confident that money management in retirement won’t make your life miserable.
This sounds reasonably straightforward, no? Just look up your account balances, run some calculations, and there’s your answer, right? That’s possible, but that’s not what will happen for most people.
Instead, as the popular finance blogger Mr. Money Mustache writes, you’ll say, “I think I’m close to having enough money to jump into… retirement, but not quite. So I’m just working one more year and starting one more side hustle and buckling down extra hard to be more certain.”
He adds, “It sounds rational, right? After all, you can never be too careful, as the saying goes. But the problem is that these people keep repeating the mantra regardless of how much money they have, and regardless of their actual living expenses. No matter how bright their financial picture is, they always find a way to undervalue their savings and overestimate their future expenses, just in case of the unexpected.”
This raises an important question: how should you actually value your savings and estimate your future expenses? The Millennial parents I work with regularly ask me, “How much money do I need to retire?” These days, there’s no shortage of financial software to run complex projections about your financial future. But numerous assumptions drive the outcomes that #fintech software produces. And many of those assumptions may turn out to be wildly inaccurate.
Instead, the most straightforward way to estimate what you need in retirement relies on the 4% rule. Christine Benz, Morningstar’s director of personal finance, recently described the 4% rule:
“A 4% starting withdrawal rate, with annual 3% inflation adjustments to that initial dollar amount, is often cited as a ‘safe’ withdrawal system for new retirees. Financial planner Bill Bengen first demonstrated in 1994 that such a system had succeeded over most 30-year periods in modern market history, and in the nearly 30-year time period since Bengen’s research, a 4% starting withdrawal rate would have been too modest.”
And the reason that a 4% withdrawal rate may be too conservative is that, as financial planning luminary Michael Kitces adds, “The 4% rule is built for environments that have horrible returns in the first part of retirement.”
In other words, if you retire at some point in the future with a $1 million investment portfolio, you should be able to withdraw $40,000 during your first year of retirement. In your second year, you can withdraw $41,200, which includes the inflation adjustment. And you should be able to continue this pattern for at least 30 years without running out of money.
Even if the simplicity and logic of the 4% rule resonates with you, you may still have a particular, nagging doubt. The success of the 4% rule ties in directly with your retirement spending, right? And how can you possibly feel assured in your 30s or 40s that your spending habits and preferences will align with the 4% rule’s framework?
Well, you’re in luck: we have reliable data to address this question, too. In Just Keeping Buying, a book that I’ve cited regularly in recent weeks, Nick Maggiulli devotes a section to money management in retirement. He writes, “When J.P. Morgan Asset Management analyzed the financial behavior of over 600,000 U.S. households, they found that spending was highest among households aged 45-49 and dropped in each successive age group. This was especially true among households in retirement age.” For example, spending among those aged 75-79 fell 15% compared to those in the 65-69 age bracket.
And J.P. Morgan wasn’t the only organization to see this trend appear in data analysis. The U.S. Consumer Expenditure Survey found that spending among households over age 75 was 25% less than households age 65-74. The Center for Retirement Research, meanwhile, estimated that spending in retirement typically declined by about 1% per year. The decrease in spending, Maggiulli notes, “occurred in the categories of apparel and services, mortgage payments, and transportation.”
“Retirees with $500k or more at retirement spent less than 12% of their nest egg within the first 20 years of retirement (on a median basis).“Ben Carlson
But these statistics clearly aren’t sufficient for many retirees. Either that, or the lived experiences of their older peers don’t influence them enough. People just aren’t convinced that their own retirement also will progress smoothly. As Michael Kitces explains:
“In a study in the Journal of Financial Planning, researchers showed that affluent retirees relying on their portfolios in retirement are failing to even spend their annual income in their retirement years (and the more affluent they are, the worse the trend tends to be). In fact, not only are retirees not fully spending their available income, but their spending actually begins to decline in retirement. As a result, from the beginning of 2000 to the end of 2008 – a very challenging time of mediocre returns for retirement portfolios, when in theory account balances would have dipped with ongoing withdrawals – the average financial assets of wealthy retirees still continued to increase in retirement. Thus, the researchers identified a “consumption gap” between what spending the retirement portfolios could support, and the lesser amount that was actually getting spent (which in turn left room for the portfolios to continue to grow).”
Similarly, financial advisor and blogger Ben Carlson highlighted a 2018 Employee Benefit Research Institute study. The study analyzed spending during the first two decades of retirement. Carlson detailed the results in a recent post:
And this split between investment and spending realities brings me back to the data point that I opened with. At the end of your life, you’re more likely to have quintuple the wealth you started with than to run out of money. Kitces elaborates:
“The decision to follow a 4% initial withdrawal rate makes it exceptionally rare that the retiree finishes with less than what they started with, at the end of the 30-year time horizon; only a small number of wealth paths finish below the starting principal threshold. In fact, overall, the retiree finishes with more than double their starting wealth in a whopping two-thirds of the scenarios, and is more likely to finish with quintuple their starting wealth than to finish with less than their starting principal!”
Ultimately, the worst-case scenario that many people fear in retirement usually doesn’t take place. But most people spend retirement – particularly the early years – expecting that worst-case scenario to soon emerge. As a result, they take an unnecessarily conservative approach to spending.
But what about when the stock market grows, on average, by about 5% annually? Then, 6 in 7 retirees are just living off that investment growth. Combine that with a social security check, and they never actually touch their initial investment balance. So how, Nick Maggiulli asks, are the retirees with investment portfolios coming close to running out of money in retirement? Isn’t that what we seem to hear from the media? But “there’s just no evidence for that in the data,” he concluded in an interview on the Standard Deviations podcast.
I’ve noted how most Financially Well listeners have plenty of time remaining to invest for retirement. Critically, we also have time to reframe our perspective on money management in retirement. As part of that particular psychological and emotional process, the blogger Mr. Money Mustache suggests two initial thought exercises:
After you’ve finished this task, stick your notes in a drawer for a few days. When you come back to it after a brief break, you’ll hopefully notice how unrealistic that situation in which you run out of money actually is. In reality, the most probable outcome looks more like the following:
“Your spending ends up a little bit lower than you expected, despite your best efforts to splurge on yourself and be generous to others. Your investments do keep going up over the long run, exceeding those conservative forecasts you made. And you do end up making bits of money here and there… even though you absolutely don’t need it.”
“In the end,” Morningstar’s Christine Benz writes, “the ‘right’ withdrawal system depends heavily on the individual retiree: his or her desire to maximize lifetime spending, preference for highly predictable cash flows versus those that are more variable, desired level of certainty around not running out, and bequest motive, among other considerations.”
All the reliable data in the world may not convince someone that they won’t be the exception to the rule. And I understand – that possibility, and the overall uncertainty that retirement presents, continues to exist until you’ve actually lived through that stage. But, for now, you still have multiple decades in which you can invest. So I encourage you to focus on what you can control. And more than anything else, that means investing consistently, over that extended period of time. While you’re doing so, though, perhaps allow yourself the possibility that the magic of compounding growth may actually make money management in retirement easier than you currently assume.
Thanks for listening to the Financially Well podcast.
[Editor’s note: this article reflects the transcript (which I’ve edited for clarity) of a recent Financially Well podcast episode.]
Kevin Mahoney, CFP® is the founder & CEO of Illumint, an independent firm in Washington, DC that offers financial planning for Millennial parents. He specializes in navigating the new financial decisions that arise during our 30s and early 40s, such as repaying student loans, buying a house, saving for college, & investing for the future. In addition, Kevin also leads a financial wellness benefits program for Millennial employees around the country, including group speaking engagements.
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