Labotka: Retirees have a lot of factors that can impact how much money they can pull from their retirement accounts. It’s not just known factors like, oh, how much money do I have in my account to start with? But it’s unknown factors too, like how long will you live? What is inflation going to look like? How’s your portfolio going to perform? There are all these unknown factors, but what we found is that about half of retirees are relying on simple hands-off approaches to deciding how much they can pull from their retirement accounts. This means that they’re using strategies that largely ignore those complex, unknown factors and pick a simple rule of thumb instead, like, “I’m just going to calculate how much I need and pull that,” or “I’m only going to withdraw dividends from my portfolio and leave the rest untouched.” Those other complex factors are kind of being ignored.
Hampton: The study showed many retirees preferred set-it-and-forget-it strategies like sticking with required minimum distributions, and you just mentioned only spending their dividends. Why do these easy approaches generally result in underspending?
Labotka: Well, in short, it’s because these strategies are not tailored to the retiree or their portfolio or the economic environment. Let me illustrate this with the strategy of just using your current expenses or deciding how much you’re going to pull. Inflation is obviously going to affect how much money you have to pull based on that, for sure. Let’s say you’ve been retired since 2016; the price of a loaf of bread has grown about 39% in that time. That certainly sounds astounding when you think about this humble loaf of bread going up 39%, and that may, in turn, make you feel like you should be more conservative in your spending habits. But by comparison, the stock market has grown over 300% in that time. Obviously, retirees don’t have 100% of their portfolio in equities, but unless they’ve had an extremely conservative portfolio, their money has likely been outperforming inflation. All of those unknown factors are important to account for because they can drastically affect your retirement picture and what you’re spending.
Hampton: That was a great example. One of the common reasons for spending less is due to a fear of running out of money in retirement. What typically happens to retirees’ wealth over time?
Labotka: Yeah, I mean, I think running out of money in retirement is one of the most understandable fears someone can have. After all, who wants to be short money in the years where you might need it the most and be able to work the least? But when we look at what other researchers have found about underspending, we find that many retirees actually see their wealth increase over retirement, so it grows. What that tells us then is that this fear of running out of money may be doing more harm than good among retirees because it’s leading them to spend quite a bit less than they might otherwise like to.
Hampton: Your team found that retirees who know that they can afford to spend more still use these conservative withdrawal approaches. Why do you think that’s the case?
Labotka: Even though these people know that they’re OK, I still think it comes back to fear and complexity. We have this very complex decision. How am I going to account for multiple unknown and shifting factors to fund my retirement for somewhere around 30 years? And the consequences of falling short are immense. Even if I know I can spend more money, what is my motivation to do so? Why would I do that? Well, whatever it has to be, it has to be great enough that I’m going to go about solving this complex problem, and I’m going to take on that slight discomfort in increasing the risk that I might possibly run out of money.
Hampton: What about retirees who work with a financial advisor or adopt complex spending strategies like the guardrail approach? How do they tend to spend?
Labotka: We had some advisor clients in our sample, and we found that they were interestingly pretty similar to the rest of the group, which is to say they tended to have a hands-off approach to figuring out their retirement spending problems; I can just give it to the advisor. I don’t need to know what he does, right? But when you don’t have a strong grasp on how your advisor is calculating your retirement income, you’re really going to have to trust them in order to spend it. Again, don’t want to run out of money close to the end of life. Because of this conundrum, it makes sense that a lot of advisors actually report that their clients have an underspending problem too.
We see a similar thing with people who have more complex strategies like the guardrails approach. Christine Benz has noted in the past that even if you use a safe withdrawal rate and adjust for inflation, you’re still probably going to have a significant balance after 30 years. Even retirees who have more-involved retirement withdrawal strategies still have a lot more money they could be spending, which points to there being a lot of runway for those with simple strategies to safely introduce some complexity.
Hampton: What are three ways a retiree could determine if they’re underspending?
Labotka: First, if you are somebody who is in that top 50% of savers and you are relying on those simple handoff approaches like withdrawing dividends, basing it on your current lifestyle, or just pulling your required minimum distributions, that could be you. The next step would be to take a look at your portfolio and your wealth overall. Is it barely declining or is it growing year after year? If it’s doing that, you might be underspending as well. The other thing I would say is to not just look at your financials, but look at your behavior. If you’re deferring essential or discretionary expenses that you can reasonably afford, that might be a sign that you’re underspending. I had one advisor come to me because he didn’t know what to do with a client who had more than enough money for her lifetime and somebody else’s, yet she was putting off taking her cat to the vet because she was worried about the cost. You can look at your finances and your behavior to help you determine whether you’re underspending.
Hampton: Well, I hope that she did take her cat to the vet.
Labotka: Me too.
Hampton: How does someone shift their mindset to enjoy their hard-earned money?
Labotka: Yeah. I’ve alluded to this a little bit already, but basically you need to find a motivation to spend. In our working years, we use retirement as a motivation to save. With that motivation, we turn saving into a habit. Now, once you’re retired, you don’t need to keep saving money for retirement because you’ve done it already, but you do have to break that saving habit, get more comfortable spending, and find a reason to do so. Even if you’re worried about running out of money, you still have to find a way to spend your money. Retirees really need vivid and personal goals to motivate them to spend their money in a way that’s going to provide them a fulfilling retirement.
Hampton: How do you recommend they set goals in retirement? How often should they review them?
Labotka: I recommend just taking some time with yourself to articulate the values that matter to you most for having lived a good retirement. Now, thinking about our values can be a little unnatural. It’s not something we tend to do. I recommend that retirees use a values framework to get a starting point for thinking about their values. Now there’s a bunch of them online. I recommend looking at the PERMA-V framework if you’re looking for one to look up on Google and be like, OK, I’m just going to take that. The reason I suggest starting with your values and then building goals off them, even though you want goals, is that the values are going to be the reason why you have the goal in the first place. That’s going to provide you a lot of motivation. It’s going to help you be able to whittle down which goals matter and which ones don’t.
Perhaps most crucially, the values are going to help you see how you can pivot when your goals or when your circumstances change, which can certainly happen in retirement. Say, you value being out in nature because it provides you peace. You might develop a goal for yourself based on that, that you want to see 10 national parks in 10 years. Great. Maybe then you go to the doctor, and you discover you probably shouldn’t be out camping under the stars that often. Instead of throwing that goal away, you can come back to the value, which is that you wanted to spend time in nature. Sure, it would be great to be able to camp out under the stars all the time, but maybe we changed the goal a little bit, where you rent an RV when you get to a national park, or you rent a cabin. You have some place where you can be in a bit more of a controlled environment for your health needs, but still get that peace of mind you get from being out in nature.
I’d say if you want to evaluate your goals, do it once a year. Tie it to something that you’re going to be reflecting during anyway, if it’s New Year’s, a birthday, an anniversary, just so you have a time where you know you’re going to be looking at them and you can evaluate whether you’re making progress toward them or if you need to switch them up.
Hampton: Finally, what’s the takeaway for retirees to avoid underspending in retirement?
Labotka: Yeah, so I have two takeaways to get them there.
Hampton: Bonus.
Labotka: Yeah. The first is just to take some time periodically to review your wealth, your spending, and your strategies for pulling money from your retirement accounts. You can tie it to the time that you look at your goals if you’d like. The idea here is that you’re starting to get a sense of whether you’re underspending and how much wealth you actually have. A lot of people in our study didn’t ever plan on changing their strategies for spending and retirement, and so they were kind of locking themselves into underspending. Give yourself time to actually check in and see if maybe you do need to adjust.
The other takeaway I have is that I need you to find a goal that gives you permission to spend because that’s going to help you get motivation to do that spending. Now, I’m not saying that you need to spend every last dime before you die and that you should be buying a bunch of trinkets or buying a lot of things that you don’t care about. No, I’m saying that you should spend more in retirement because you deserve to have a fulfilling retirement that is funded by your money, that’s enabled by your wealth. Giving yourself goals that really allow you to live a life that you want to lead is going to help you with that underspending problem too.
Two things: Just make sure you periodically check in on your withdrawal strategies, and make sure that you have a goal. Now, you’re not going to necessarily cure yourself of underspending, but as long as you’re living a life that you enjoy and your wealth is enabling a happy retirement, I’m going to count it as a win.
Hampton: I think you have given us the game plan that we can work with. Thank you, Danielle, for being here and sharing these great tips.
Labotka: You’re welcome. Thank you for having me.
Hampton: That wraps up this week’s episode. Thanks for making this show part of your day. A couple of reminders: Give Investing Insights five stars on Apple Podcasts to help others find the work we’re producing for you, and subscribe to Morningstar’s YouTube channel to see new videos from our team. Thanks to senior video producer Jake Vankersen. I’m Ivanna Hampton, editorial multimedia manager at Morningstar. Take care.
