Lee Eisenberg wrote a book in 2006 about the amount of money and resources people will need to enjoy the active life they desire, especially post career, titled THE NUMBER: A Completely Different Way to Think About the Rest of Your Life. Theoretically there is an amount of money each person needs to have in order 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 the major focus on growing assets. Indeed, part of the retirement equation is the amount of money saved. The other part of the equation with equal significance is the amount of money a retiree plans to spend.
Spending is the overlooked variable pre-retirees should pay a lot of attention to. The ability to control spending should be acquired as a prerequisite for retiring. 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 things we don’t have much control over. However, we can control what we spend our money on and therefore change how much 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. In fact, without a budget you may not have control over your spending. 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 and necessities in advance. This gives you the control you need to make sure important 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 reach retirement. It also provides confidence you will be able to live on the income you’ve projected because you now have the skill you need to adjust spending if needed in the future.
The New York Times recently reported the median household income in America during 2012 was $51,000. Replacing this income would require an investment account of $1.28 million assuming a 4% withdrawal rate. It would take this household 38 years of saving 10% of their income ($5,100 per year) to accumulate $1.28 million if their savings grew at 8% per year. They would have to create a budget disciplining their spending to $45,900 per year in order 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 $1.15 million to produce spendable income of $45,900. Only 37 years of saving 10% is needed to accumulate this amount using the same assumptions. Controlling spending is an important key to financial planning.
This is a very simple illustration which doesn’t take into account inflation or taxes. It also doesn’t take into account wage increases that typically follow a person’s career as they enter the workforce and become more valuable. It is certainly possible to shorten the 37 years it takes to replace a person’s earned income when they discipline their 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.
As we approach the end of 2013, use this time to reflect on your annual expenses. The financial markets have been kind this year but they may not be in 2014. It’s time to review your budget to make sure you have your spending under control.
- Spending is an important 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 a large impact on the amount you need to retire and ultimately when you can afford to retire.