Tuesday, July 29, 2014

Spending Levels in Retirement

The article focuses on the range of annual available spends during retirement.  Here are some thoughts on how the spending levels might affect investments.

How much will you need in retirement, and how does investing tie into this?  To what extent might (should) a retiree be willing to risk not reaching planned spending levels?  Consider these three levels of spending.

               Spending Level 1.  A sustenance level where the individual or couple lives healthily with little more, say 40-50k.

               Spending Level 2.  Minimum happiness level.  Daniel Kahneman and others have concluded that there is a spending level above which additional income does not bring more happiness, say 80k.

               Spending Level 3.  A level above Level 2 that maintains (or exceeds)  the pre-retirement lifestyle, say 100k or more, with no upper limit.

Most retirees will fall somewhere in the first two levels.  How much safety is required at each level?  Considerable conservatism, perhaps using a liability matching portfolio of annuities or a TIPS ladder, will likely be optimal at Level 1, and some similar degree of conservatism may be desirable at Level 2.   No rules seem appropriate for Level 3.

Richard Thaler and many others have written extensively on the behavioral aspects of investing.  The behavioral aspects of spending don't seem to have received much attention.  Some at Level 3 are extremely frugal and others are spendthrifts.  Some need to keep up with the Joneses, others could care less.  Some are flexible in lifestyle and others inflexible.  Some have an irrational fear of running out of money, and some are eternal optimists.  Even at the level of super wealthy, we have Warren Buffett and Dennis Kozlowski.


For those at Level 3 it is likely unnecessary and too costly to create a LMP to assure certain spending availability.  When considering all of the behavioral differences, it seems clear that there is no single formula that will apply to all.  At Level 3, all planning must be ad hoc.  

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