Coming up with a spending strategy for older clients is no easy task. Financial advisors can’t acquire more money for these clients once they’re in or near retirement, and they can’t increase their portfolio’s rate of return significantly without piling on unacceptable levels of risk.
The good news is that most retirees end up spending less than they think they might, says David Blanchett, head of retirement research, investment management, for Chicago-based Morningstar Inc. in a Journal of Financial Planning (JFP) paper entitled “Exploring the Retirement Consumption Puzzle.”
There’s often an initial spike in consumption when people retire, which generally tapers off, Blanchett maintains. In most instances, in a pattern that he labels the “retirement spending smile,” spending actually drops with age.
When Blanchett looked at retirement spending across several types of households, he found spending declined, after adjusting for inflation, by approximately one percentage point a year on average. However, spending did pick up a bit in later years because of higher health-care costs.
This pattern holds true especially for wealthier households, which typically enjoy more discretionary pre-retirement spending, and thus have more flexibility in retirement to cut back if their retirement income proves inadequate. The implication is that any households that aren’t consuming savings optimally will tend to adjust the spending pattern during the retirement period (i.e., spending does not remain constant in real terms).
As a result, Blanchett maintains, employing a strategy that calls for an inflation-indexed income in retirement of 70% of pre-retirement income could lead to serious miscalculations when plotting your clients’ financial future. Thus, the amount that many clients actually will need to fund their retirement will be overestimated significantly.
Rather than looking solely at retirement income, you also need to understand how retirees actually spend their time, says Charlene Kalenkoski, professor in the department of personal financial planning at Texas Tech University, in another JFP paper entitled “How Retirees Spend Their Time: Helping Clients Set Realistic Income Goals.”
Most people who are employed full-time spend seven or more hours at work each day. Once they retire, however, much of the time they used to spend working turns into leisure time.
Although conventional wisdom suggests that retired clients will ramp up spending on expensive leisure activities, Kalenkoski’s findings suggest that most retirees don’t make huge changes to their lifestyles; rather, retirees tend simply to linger longer over the things that they enjoy. And much of that leisure time is actually spent on inexpensive or even cost-saving activities.
These results suggest that you should quiz your clients regarding how they actually plan to spend their time in retirement, and remind them that their future expenses may not climb as much as may be anticipated.
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