I believe some financial industry maxims are very far out of touch with the values and goals of American retirees. The result is we are losing an opportunity to communicate information that can provide great help on a most complex issue: how to manage money in retirement.
Let me start with the values and goals of retirees and then turn to the advice and viewpoints that I fear is far off the mark.
In over 40 years of research with retirees, I continue to be impressed with the financial adaptability of retirees. A key psychological need of retirees is to feel financially secure and they have one key metric to evaluate their level of financial security: their asset level. Furthermore, there is a key reference point for their evaluation of their asset level: how has it changed since the date they retired. If their asset level has gone up, they tend to feel good. If their asset level has gone down, especially a lot, they tend to feel threatened. There has been a great deal of discussion of the loss aversion of consumers, but little understanding that this loss aversion also covers a loss of asset level in retirement.
A few basic precepts of the financial services industry and economists are far out of touch with this metric for evaluating financial security. The idea of systematic withdrawal is rejected by most retirees; they do not want to spend their asset levels down to zero or even close to zero. The theory of life-cycle saving and dissaving subscribed to by many economists assumes that people will build up assets during their working years and gladly spend this money down once they retire. The main problem with the theory is that it is simply does not apply to many retirees. My favorite quote on this point is from a recent article by a number of fine economists published in the highly respected National Bureau of Economic Research: “The elementary life-cycle model predicts a strong pattern of dissaving in retirement. Yet this strong dissaving is not observed empirically. Establishing what is wrong with the simple model is vital for the optimal design of Social Security, Medicare, Medicaid, retirement savings plans, and private insurance products.”[i] Yes, as these economists state, the pattern is not observed empirically because it does not fit the way most retirees wish to live their lives.
A lot of retirees have spending that is highly flexible, and they will control their spending to help maintain their asset level. One distinction I have often heard from retirees is the difference between “needs” and “wants.” Many, especially those more affluent, say they did not make this distinction when they were working; there was more money coming in and they could satisfy “wants.” But, in retirement, many assert they have fewer needs and do not mind giving up wants in order to focus on what is most important to them: preservation of asset levels. They strongly value the feeling of financial security they get this way. Very importantly, they do not know what other metric to use to evaluate their financial security except retaining asset level.
Only a minority of retirees want to maintain consistent spending in the face of varying equity market performance, and those that do tend to have lifetime income from defined benefit plans that allow them to be less dependent on the market and provide the income they need to meet spending needs. As the proportion of people with lifetime income from defined benefit plans continues to go down, that viewpoint will be heard even less.
Let me comment on a maxim that misses the commitment to flexible spending to preserve asset level. The 4% rule suggests that people should save as much as would be needed, on an inflation adjusted basis, to be able to maintain consistent spending. This rule is based on an evaluation of how much consistent spending could be maintained, increasing spending to keep up with inflation even in the very worst times to retire in almost 150 years. Those terrible years to retire were: 1) right before the Panic of 1907, 2) during the Great Depression, and 3) before the stagflation of the 1970s. Those who retired then could have spent 4% a year consistently (increasing the nominal spending to keep up with inflation and have money available after 30 years). How many people do you know who would have kept their spending consistent if they retired during the worst three times in almost a century and a half? Are we doing people a favor by suggesting that if they want to keep assets above zero for 30 years of retirement they should save far more than would have been required by those who retired in the three worst times since Ulysses S. Grant was President?
Our research suggests that almost everyone in circumstances much less severe than those would adjust their spending. These adjustments would allow them to have had enough money to get through these extreme bad times even if they had saved 20% less. In less horrible times, they could have saved 33% less and still had money at the end.
Most retirees try to maintain (or even grow) their asset level. Yet, they have no real justification for this goal. Most seek to retain their assets because they do not know what a secure level of assets should be at age 70, 75 or 80. This is where financial advisors should come in. It would be quite useful for advisors to provide their clients with three and five year goals for their assets based on spending flexibility.
Clearly, investment returns in the first five years of retirement can have a powerful affect on the ability to maintain financial security throughout retirement. It is far less important if a new retiree spends 3%, 4%, 5% or 6% of assets per year for the first two years of retirement than if the equity market goes up 25% in that period or down 25% in that period. When setting goals, the key is asset level, not spending level.
Many of the old maxims offered to people planning to retire and just retired don’t provide the guidance needed. We should try to do a better job of telling workers how much they need to save, based on their sense of the flexibility of their spending and better rules of thumb on asset levels needed a key mileposts after retirement.
[i] “Long-term Care Utility and Late in Life Saving,” National Bureau of Economic Research, Working Paper 20973, February 2015, John Ameriks, Joseph S. Briggs, Andrew Caplin, Matthew D. Shapiro, Christopher Tonetti