In 2006, Lee Eisenberg wrote THE NUMBER: A Completely Different Way to Think About the Rest of Your Life, which detailed the amount of money and resources people will need to enjoy the active life they desire, mostly post career. Theoretically, there is an amount of money each person needs to maintain their lifestyle through the end of life expectancy. The financial services industry spends a lot of time and money trying to help people accumulate their “number,” with a significant focus on growing assets.
Indeed, part of the retirement equation is the amount of money saved. The other part of the equation, which is just as significant, is the amount of money a retiree plans to spend. Spending is an important variable that is often overlooked. Pre-retirees should acquire the ability to control spending as a prerequisite to retirement.
Future earnings are always uncertain. The stock market could grow like it has in the past, or not. Social Security could pay the benefits promised, but it could also be changed. These are variables no one has control over. However, we can control what we spend our money on and therefore change the amount we spend.
Start by creating a budget. Many people have told me they didn’t realize how much money they were spending until they made a budget. Some will argue a budget is too controlling. There is a lot of truth to this. But the fact is, without a budget, your spending can control you. Money comes in and goes out without a plan, which leaves room for unpleasant surprises. With a budget, you plan the amount of money you expect to receive and how it will be saved or spent. You get to determine how much is spent on fun or necessities in advance. This gives you the control you need to make sure essential expenses are planned for, and money is saved for long-term goals.
Living within a budget teaches discipline. Money discipline is a critical skill to acquire before retirement because it could lower the “number” you need to retire. It also provides confidence that you will be able to live on the income you’ve projected, because you now have the skills you need to adjust spending if required in the future.
According to the U.S. Census Bureau, the median household income in America was $68,703 in 2019. Replacing this income would require an investment account of $1.72 million, assuming a 4% withdrawal rate. It would take the median household 42 years of saving 10% of their income ($6,870 per year) to accumulate $1.72 million if their savings grew at 7% per year. They would have to create a budget disciplining their spending to $61,800 per year to save 10%.
However, the goal was to replace their spendable income, and by reducing their spending, they’ve lowered their goal. They now only need $1.55 million to produce a spendable income of $61,800. Using the same income and performance assumptions, only 40 years of saving 10% would be required to accumulate this amount. Controlling spending is essential to financial planning.
This is a straightforward illustration that doesn’t take into account inflation or taxes. It also doesn’t consider the wage increases that typically follow a person’s career as they enter the workforce and become more valuable. It is undoubtedly possible to shorten the 40 years it takes to replace a person’s earned income with disciplined spending. Unfortunately, too many people increase their spending faster than their income through the use of credit. They end up using much of their working life trying to get out of debt rather than accumulating the assets they need to become financially independent.
Creating a spending plan is one of the critical issues to address in phase one of AGILE: “Assess Your Goal.” Phase one is ten years before retirement. We also work with our clients entering phase three, “Implement the Plan,” by asking them to live on their planned spending the year before retirement. We want to make sure the spending amount is right to be confident their “number” is correct.
- Spending is an essential part of the retirement planning equation.
- A budget helps you plan how to spend your money before it arrives.
- Small adjustments in spending could have an enormous impact on the amount you need to retire and, ultimately, when you can afford to retire.
Originally published October 2013