At the AICPA Personal Financial Planning conference in January, Jim Shambo, president of Lifetime Planning Concepts of Colorado Springs, Colo. - an out-of-the-box thinker if ever there was one - asked a deceptively simple question. Our Monte Carlo engines assume that clients will spend a certain percentage of their total retirement portfolio in the first year (4% is the safe harbor amount), and then require that same dollar amount, going forward, for the rest of their days, adjusted for inflation. Analyses by Jon Guyton, a principal of Cornerstone Wealth Advisors in Minneapolis, and others show that we can adjust that safe harbor upward a bit if clients are willing to freeze their spending in down markets and limit their raises.
But what Shambo wondered is this: Is the constant-dollar spending goal an accurate or reasonable assumption?
To find out, he looked at inflation calculations by the Bureau of Labor Statistics and found something interesting: Inflation tends to strike retirees harder than preretirees. Most notably, health care costs are rising faster than the inflation rate.
Beyond that, the CPI calculation factors out cost increases that are attributable to improvements in the goods and services you purchase. A car may cost 4% more this year than last, but if there are new fancy electronics in the standard model, the government may decide that inflation only counts for a half-percent of the increase. Of course, if you buy the car, you still have to pay the full higher cost. Add it all up, and people aged 65 to 74 appear to be experiencing an inflation rate that is a remarkable 1.11 percentage points a year higher than CPI, and this grows to 2.09 percentage points (a year!) when retirees get past age 75.
MAKING A MODEL
A sophisticated retirement spending model, created by California Lutheran University Professor Somnath Basu, combines Shambo's revised inflation estimates with these revised expenditure figures. Each line item gets its own estimate of higher or lower consumption, and that's multiplied by an individualized inflation factor.
Health care spending will tend to go up as clients age, and medical costs rise faster than CPI. Food expenditures tend to go down as people age and food inflation is typically lower than the average, and so forth.
I asked the audience of my Inside Information newsletter what they thought of all this, what their experience has been with retired clients, and how (or whether) this more sophisticated retirement spending model would change their advice to clients. The most common response is that generalizations have to be pushed aside when you're dealing with an individual client.
When David Jacobs, who practices in Honolulu, estimates a client's retirement spending, he takes into account such driving factors as the size of the house and maintenance expenses, a habit of providing significant financial assistance to children, a dependent parent, and/or costly activities on the bucket list. This latter line item gets particular attention from Tom Murphy of Temaa Financial, who practices in Dallas. After studying the behavior of his clients closely, he has started planning for a spending blip in the first two years of retirement. That, he says, is when clients take full advantage of their newfound freedom.
Elyse Foster, of Harbor Financial Group in Boulder, Colo., builds a larger portfolio buffer for what she calls "spendy" clients. Meanwhile, both Neal Van Zutphen of Delta Ventures Financial Counsel in Phoenix and Cindi Conger of Conger Wealth Management in Little Rock, Ark., are pioneering a detailed budget planning service for their clients.
Each expenditure is assigned its own line item and there are projections both for spending increases or decreases and individualized inflation rates. Clients get in the terrific habit of tracking their expenses against the projections before they enter retirement, and are far less likely to get off-track when their paycheck runs out.
At the other end of the spectrum, Pat Raskob, who practices at Raskob Kambourian Financial Advisors in Tucson, Ariz., finds that some retirees who were champion savers in preretirement are unaccustomed to the frivolity of leisure activities. She has to coax them along, brainstorming fun things for them to do, helping them purchase trips and plan activities with their children as well as their grandchildren.