How much do you need to save to achieve your monthly budget for retirement? This question exemplifies how traditionally, retirement planning tools rest on an assumption that somehow, magically, once we retire, our expenses will be static. Experts point out that this is of course an overly simplistic assumption and offer new ideas about retirement modeling.
Retirement Risks
Flawed assumptions lead to flawed guidance, flawed portfolio choices—and flawed paths to retirement. Traditionally, modeling treats spending purely as “need”—which is unrealistic. Though it is important to budget for essentials, better navigation of the borderline between needs and wants can help retirees adjust and manage spending over time—and depending on portfolio performance. As David Blanchett explains to the National Association of Plan Advisors:
We explored how incorporating flexible spending in retirement modeling can impact the definition of the optimal retirement portfolio. First, we split the retiree income goal into two types of expenditures: “needs” and “wants.” Needs are relatively inflexible spending that the retiree can’t live without—things like housing and healthcare costs. Needs spending is sometimes called essential or non discretionary spending. Think of wants as more flexible spending that the retiree would like to have but is willing to adjust as situations warrant, like travel or entertainment. Adjustments may include both increases, if the portfolio does well, as well as decreases, if the portfolio does poorly….While some portion of every retiree’s income goal is likely going to be for essentials (we estimate about two-thirds on average), this is going to vary by retiree.
Building out from this thinking, advisors and savers can take a more holistic approach to risk levels when selecting portfolio allocations. For example, with greater clarity on the flexibility that lies between needs, wants and even wishes, comes greater insights into how much risk is most appropriate when thinking about investments options that will take us to—and through—retirement. Experts offer this example:
For many retirees needs spending may be covered by existing sources of guaranteed income, such as Social Security retirement benefits or a pension. This leaves the retirement portfolio (whether it be a 401(k), 403(b), IRA, etc.) to cover remaining needs spending and wants spending. A retirement portfolio focused on funding wants spending can typically be more aggressive than a portfolio focused on needs, especially for a younger retiree (e.g., someone who is 60 versus 75). A retiree focused on covering needs spending with their retirement portfolio is going to typically have a greater focus on consistency and therefore may prefer slightly less risk, on average. A retiree who is investing the portfolio to cover wants spending (because the needs is covered through guaranteed income) is likely going to be willing to take on more risk, on average, because the potential pain of shortfall isn’t as great and is offset by the expectation of higher returns.
Insufficiently Prepared
Regardless of whether budgeting for needs, wants or wishes, most employees are not saving enough for retirement—and know it. For example, Plan Sponsor shares these key findings from a recent survey: “69% of U.S. employees surveyed recognize they are not saving enough for retirement… Additionally, people closer to retirement are more likely than before the COVID-19 pandemic to say they will retire beyond the age of 70. The top three reasons employees cited for not saving more for retirement were paying off debts (36%);…purchasing a car or paying for education (28%); and not being able to afford to save more (27%).”
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