Have you ever walked through a busy airport, bus terminal or train station and watched people move through the crowds? Our movement in a complex environment is incredibly impressive. We can have thousands of people running through a crowded environment without bumping into each other. It's so impressive that researchers study crowd movements to help improve traffic and other systems. When placed in a crowded environment, we exhibit extreme adaptability and self-organized collective behavior that allows us to modify our paths based on what happens next.
This adaptive approach to traffic and movement control is a great analogy to the change in approach that must occur with retirement planning. We need to move from a static approach, like driving on a freeway, to a more adaptive approach like driving through an airport. Reason? There are too many changes, changing 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; nor can our planning be.
Often, we approach retirement income planning as a math problem. We take a spending or distribution rate and test it against historical performance, adjusting future spending for inflation. For example, finding the safe withdrawal of 4% takes a fixed spending rate per year and adjusts it for inflation over time. But in addition to the increase in expenses due to inflation, the analysis does not take into account the change in the dynamics of expenses over time.
We don't spend like that in life. In life and retirement, we won't just read a fixed expense and adjust it for inflation every year. Instead, real costs tend to decline through retirement, until the end, when they may begin to rise due to medical and long-term care expenses. This creates a sort of smiley curve of retirement spending for most retirees, higher in the early years, falling over time and rising again in later retirement years.
If you readjust the 4% safe withdrawal rate study and instead of using a constant inflation-adjusted spending rate, you adjust for the smiley spending curve of real spending declines, the sustainable withdrawal rate increases. According to some research by dr. David Blanchett, could raise the initial withdrawal rate closer to 4.73%, increasing initial spending rates by nearly 20 percent. If you think about it, that's a lot more spending to begin with when spending is likely to provide the greatest utility or happiness for every dollar of spending.
Additionally, if you look at retirement in buckets and rely on mental accounting, you can prioritize when and where to cut your expenses even further. Research has shown that if you are willing to adjust spending to wants and needs as your retirement funding levels rise or fall, you can improve the stability of your retirement income portfolio while simultaneously increasing total spending during retirement pension. Success and failure rates assume that a person is not willing to cut back every year for every expense in retirement, which is simply not true. Instead, you can make short-term adjustments to cravings to make the plan more sustainable. Adaptive retirement income planning is a lot like diversification, it's the closest thing I've 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 expenses during certain periods of time 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 do the math and science match up with a wait-and-see approach based on adaptation to retirement, but the behavioral side of retirement also matches up. You've likely heard of the waning years, the slack years, and the unattainable retirement years 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 satisfaction from our spending. As we age and can no longer get as much pleasure from the same activities, we are likely to cut back. This ties our spending into both a more sustainable approach to retirement income planning, but also a behavioral and life-satisfaction approach to getting the most out of our money.
This approach also moves us away from the hit or miss approach of many retirement income analyses. Success or failure for retirement projections is very binary and is really only showing us a situation where our investment assets have been depleted – it doesn't actually mean we've failed in retirement!
Instead, an adaptation-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 take on our spending plan. This is much nicer and more human first. People budget and make cuts all the time. In fact, any approach that suggests Americans will not adjust spending during long-term economic downturns or periods of high inflation is ignoring research and historical behavior. Americans are resilient and we adapt during these times, even if we have steady streams of income.
According to a Financial Planning Association Survey and Jonathon Guyton, clients who approached retirement income with a first-floor security approach were more likely to cut back on 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 macroeconomic and inflationary factors. As such, our planning as professionals must account for people's adaptive way of life.
Finally, this is how we live our lives. We adapt as things change. An adjustment-based retirement income plan is not a critique of research like the 4% finding, but an improvement on previous research. As our learning and technology have improved, we can run more complex financial models and forecasts. 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, on average, less flexibility in their retirement spending than higher-income individuals. As such, everyone may not be able to cut back as much if their retirement funding levels start to decline.
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 speak in Edge Wealth Management. Join Jamie along with 2000 senior executives present now.
