Spending, not saving
“Retirement is when you stop working for a living and start working at living.”
After a few emotionally heavy Substack posts, an iMessage conversation with a friend prompted me to think about a lighter, more practical topic. My friend speculated on an inverse correlation between financial savviness and emotional intelligence, and he had a personal example. His own financial savviness has put him in a good position financially towards retirement. However, on the emotional side, he couldn’t shake his “catastrophic thinking” regarding his financial safety.
He asked me for my thoughts on how to overcome his psychology of “catastrophic thinking.” I wanted to use this post, the first of two, to explore a psychological hack of utilizing one’s own goal-oriented mindset to set “spending” rather than “savings” goals.
(My next post will consider the “what-if” world of the 20% of scenarios in the Monte Carlo simulations that many “approved” retirement plans fail. Most of the time, investment advisors counsel investors to target above an 80% confidence level! What about the other 20%?)
See our iMessage thread below.
Not alone
My friend is not alone in his “catastrophic thinking.” A 2024 Survey by Allianz Life reported that nearly 2 in 3 Americans fear running out of money more than death.
“The worry of running out of money has increased in recent years. In 2024, 63% say they worry more about running out of money than death, up from 57% in 2022. Gen Xers are the most likely to say this with 71% more worried about running out of money than death, compared to 64% of millennials and 53% of boomers.”
Of course, some of this widespread fear might be justified. According to USA Facts, in 2022, about 46% of households reported any savings in retirement accounts. Only 26% had saved more than $100,000. As mentioned in my previous post “There is no magic number,” this post targets those in the luckiest quartile who have been able to have steady work, avoid crippling expenses, and save money.
For this lucky quartile, how does this fear manifest itself?
The statistics
Longitudinal studies demonstrate that retirees with healthy retirement savings are not spending as much as they can afford to spend, often foregoing retirement plans or accepting unnecessary reductions in their quality of life.
A 2014 paper (Browning, et al) described the “retirement consumption gap” (RCG) that demonstrates the levels that retirees do not spend, even after accounting for bequests (what is passed down to heirs in a will) or unexpected expenses. The study utilized data from the University of Michigan Health and Retirement Study.
“When incorporating the effects of uncertain longevity, uncertain medical costs, and bequests we find that retirees with median wealth have a consumption gap of approximately 8% on average and that retirees with higher levels of wealth have a consumption gap as high as 45.6%.”
A follow-on working paper (Blanchett and Fink 2024) utilizing the same HRS study data focused on subjects with assets over $100,000 and spending within a reasonable range to remove outliers. The criteria were designed to limit the analysis to those spending within a reasonable range, i.e., at least 25% and not more than 400% of the available resources, considering both income (social security, pension plans, investment income, etc.), as well as assets. Within these constraints, the authors found that the gap in spending was caused by retirees not withdrawing from their portfolios at the rates they could.
“Savings are spent at levels that would generally be considered less than optimal. For example, observed spending (i.e., withdrawal) rates from savings were only approximately 2.1% for 65-year-old married households (versus 1.9% for single households). This is significantly less than general guidance on portfolio withdrawal rates (e.g., the “4% Rule” for a 65-year-old couple).”
The study found that retirees do spend income (e.g., social security and pensions). However, retirees resist withdrawing from their portfolios during retirement to fully take advantage of their careful planning. This behavior is somewhat understandable, as these habits to avoid touching their portfolios are what got them to an otherwise successful retirement savings plan in the first place. Old habits die hard!
A “strategy”
Blanchett and Fink recommended a psychological hack to get retirees to spend at the targeted levels. The strategy was to simply reposition the portfolio assets that retirees are reluctant to spend into lifetime income that they are more apt to spend by purchasing annuities.
Annuities are contracts that are issued and distributed by an insurance company and bought by individuals. The insurance company pays out fixed or variable income streams to the individual beginning for a specified period of time or for the remainder of the individual’s life. The concept is to help individuals address the risk of outliving their savings.
There is a “Dr. Evil” plan going here, as the paper author David Blanchett is the Managing Director, Portfolio Manager, and Head of Retirement Research for PGIM DC Solutions, which is the investment management arm of Prudential Financial — a company that sells annuities. (I call these plans “Dr. Evil” plans because the character Dr. Evil from the Austin Powers movies hatches up “secret” plans that he tells everyone about!)
The paper offers a call-to-action for policymakers to incentivize the purchase of annuities.
“This suggests that policy can significantly raise rates of spending among retirees resulting in increased welfare and higher aggregate consumption among older Americans. For example, policies that incentivize or default the annuitization of retirement wealth could significantly increase spending among retirees.”
— Blanchett and Fink
Of course, what the authors do not call out is that annuity products come with high fees, at a significant profit to offerers like Prudential Financial.
“Annuities are considered poor investments for many reasons. Depending on the annuity, these include a variety of high fees, with little to no interest earned, an inability to keep up with inflation, and limited liquidity.”
So, even though there’s an interesting psychological hack here to reposition assets which the retiree won’t spend into an income stream that the retiree will spend, I don’t recommend it.
What is recommended?
The hack that Blanchett and Fink are really trying to engineer is a spending goal. By setting a target annuity payment, they are really trying to get people to admit what they’d like to spend in retirement to live the lives they want.
Instead, I propose that people skip the annuity and just set a spending goal.
Why a spending goal? With financial savvy, the educated investor should know that the ideal spending in a well-designed retirement plan is to end up with $0 after accounting for bequests and unexpected expenses. (And sometimes, unexpected expense allowances can be big. Our financial advisor recommended a whopping $1M for unexpected expenses!) Still, we know from the research that most fail here to spend. The educated investor should also know that the psychological hack to buy annuities to overcome this failure can result in a bad deal.
So, what’s the option? Do the reverse of what created the successful retirement plan before retirement to execute a successful retirement during retirement.
Ditch the savings goal and set a spending goal.
Utilize dollar-cost averaging in reverse. Rather than using it to avoid trying to time the market when buying in, use it instead to sell out.
Be flexible. While savings goals are often ones that people often choose to keep very rigid (e.g., “15% of pretax income per year”), spending goals can be flexible as different opportunities in life arise.
For example, the financial advisor of someone we know has started him on this strategy by advising him to set a target budget to spend on travel every year, rather than by setting savings targets. This mindset gives him a license to break the habits that got him to a successful retirement savings portfolio to begin with.
Other resources
Beyond the industry and academic research I have cited, there are many resources available in the popular press, as this phenomenon among retirees with healthy retirement savings is common. Here are just a few:
Associated Press, “The Psychology of Retirement Income: From Saving to Spending”
Again, my friend isn’t alone here in “catastrophic thinking.” However, he is also very goal-oriented and simply needs to shift the attitude on money from the goal itself (i.e., “a magic number”) to being just a tool to enable more pressing goals that can only be achieved by stepping away from the grind of day-to-day work and doing some spending.
I hope this post gets you thinking! I’ll dive into an orthogonal track on Sunday!
Similar kind of thinking fleshed out further in the book "Die With Zero" by Bill Perkins.
I echo previous comments, excellent post. I found one of the hardest things in retirement was changing my mindset from accumulating wealth to starting to spend wealth. This manifested in several ways, including recognition that I could retire and no longer even needed to consider making more money. I am also fortunate and realize I will not meet my goal of spending my last nickel and then taking my last breath. The new decisions are giving our children some of our wealth before our death, when it can do more good for them.