Should Your Retirement Spending Change Due to Inflation and Volatility?
When I think about the start of spring, I think about spending the Easter holiday with my family, the colors returning to our green spaces, a little more sunshine, and maybe a shower or two.
Hail the size of baseballs? Not a part of my vision!
But that’s what a massive storm brought to Kansas City a few weeks ago. Like so many folks, I'm still fixing broken windshields and dents on my family's cars and having my roof checked out.
Of course, none of us can control the weather. But we can prepare for the unexpected by buying insurance, keeping some emergency cash in our savings, and making home upgrades that protect our most valuable assets.
And, as we discuss on today's show while answering three timely listener questions, the same principle applies to financial planning. We can't control what's happening in the world or how the markets react to the news of the day. But we can be proactive about how we weather the storms of inflation and volatility.
1. "How should we account for the uncertainty in inflation and investment returns for long-term planning?"
This question is at the heart of what we do for folks every single day at Keen Wealth.
When we're building a retirement plan that needs to support someone for thirty years or more, we account for a mix of known inputs and variable inputs.
Your knowns would include things like your assets (retirement accounts, savings, real estate) and consistent income streams (Social Security, pensions).
For variables that don't progress in a straight line, such as what we expect your investments will earn, or how much inflation could affect your purchasing power, we have to make projections.
When it comes to inflation, you can't just expect the current rate to continue for the next couple of decades. Instead, we project how much your baseline spending needs could increase over time and make a spending plan to maintain your current standard of living in different inflationary environments.
We then use statistical modeling (sometimes called "Monte Carlo simulations") to stress test your plan in thousands of financial scenarios: different rates of return, randomized market corrections, varying inflation spikes, and so on. This helps us measure the potential for a sequence of returns risk -- the danger of retiring into a market downturn. We need to be confident that your plan will support you when the going is a little rough, not just when conditions are perfect.
Finally, keep in mind that while the rate of inflation may drop (as it has this year), prices rarely drop back in tandem. In most 30-year retirement scenarios, it's important to have a portion of your portfolio participating in the equity markets and growing your wealth so that, in addition to your other spending needs, you also keep up with inflation, taxes, and medical costs.
2. "Do spending habits and goals need to change with the ups and downs of the market?"
Ideally, not very much.
A properly diversified financial plan should be able to maintain your baseline spending – and cover some bucket-list fun – regardless of what the markets are doing.
Now, in extreme circumstances, like 9/11, the Great Recession, or COVID, I've often seen retirees pull back their spending. Not because we advised them to and not because they were worried about making their mortgage payments. It was because, after a lifetime of working hard and growing their wealth, they had built up good financial habits and were discerning about their spending to begin with. They were also clear-eyed about the differences between their Needs, Wants, and Wishes, and they had the resources to make a few adjustments here and there to stay on track towards their goals, even during market downturns.
3. “What percentage of someone's original income do people typically spend in retirement?”
The most common answer you'll find on Google or social media is that you'll need your nest egg to replace 70-80% of your pre-retirement income to maintain your standard of living. The idea is that you'll probably cover the remaining 20-30% just by not paying FICA tax anymore and by slowing down your saving and investing rates. Some spending might also dip at the beginning of retirement, such as work expenses, debt repayment, and the costs of raising kids.
However, according to a recent report from JP Morgan, the lower your pre-retirement income, the higher the percentage you'll probably need to replace in retirement. That's because lower earners typically spend a high percentage of their earnings on essential fixed costs (mortgage, utilities, etc.), whereas high earners tend to have the resources to spend and invest more, which gives them a bigger cushion in retirement.
Plan on Sunshine, Prepare for Rain
Ultimately, your life should be at the center of your financial plan, not the weather on Wall Street.
But if you have questions about how geopolitics and market movements could affect your financial plan, call up Keen Wealth and let’s talk.
About Bill
Bill Keen is a financial advisor with over 30 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he focuses on providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to Forbes, U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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