Are you underspending in retirement?

Studies consistently show that the top concern for retired investors is running out of money, followed closely by anxiety over determining how much they should be withdrawing from their portfolio. The media seems to enjoy reporting on this fear. A Google search for "running out of money in retirement" yielded 2,170 records! Meanwhile, a similar search for "underspending in retirement" turns up just six entries.

However, my experience in more than 20 years of working with retirees in the Delmarva Region is that this fear is greatly overblown. In fact, only in rare cases, usually accompanied by an unusual circumstance, have I seen a retired investor completely spend down their investment assets. The far more common scenario is to see a portfolio grow over a long-term basis at a faster rate than the associated withdrawals.

In other words, rather than running out of money, most clients are actually underspending. This is an odd phenomenon, particularly since most retired investors tell me that their primary goal is to use their retirement investments to supplement their income and to be prepared for unforeseen contingencies, not to create wealth for their heirs. And yet, that is what I often see; retired investors' wealth tends to grow over their retirement, not diminish. Part of this trend can be attributed to the fear of running out of money, but I suspect there is more at work here.

Those who have successfully retired with adequate financial resources often have a strong savings habit. For decades, they faithfully put money aside into 401Ks, IRAs and investment accounts to save for their retirement. The years of frugality and delayed gratification necessary to build a sustainable nest egg create ingrained habits which are difficult to break. It initially feels awkward to actually pull money out of accumulated savings during retirement.

Retired investors also frequently experience heighted anxiety and uncertainty over market turbulence. They had anchored their investing time horizon to their retirement date, and now that they are retired, their time horizon has become unmoored. They don't know if they should be short-term investors, or are still long-term investors. With no paycheck coming in and no more contributions to the savings plan, every market drop feels pronounced and potentially terminal.

There's also a behavioral bias at work. Culturally, we are taught that, although it may be OK to spend investment income, one should never, ever spend down the principal. Again, this may be a worthy philosophy for those saving for retirement, but perhaps detrimental for retirees. So long as the distribution is methodical and part of a spending plan, I see no problem at all in spending down interest and principal over the course of retirement.

The solution, I believe, is to create a written retirement income plan which addresses not only necessary spending, but also a healthy amount of discretionary, fun spending. After all, the gratification need not be delayed any longer! According to a Wall Street Journal report, only 34 percent of those nearing retirement have even estimated their retirement expenses. Awareness of what your income needs and goals are is key in creating a plan.

Second, create a sustainable drawdown strategy. Several decades ago, William Bengen, a financial advisor in California, created the 4 percent rule. Based on extensive research, he calculated that a well-diversified, balanced portfolio could sustain a 4 percent withdrawal rate. Of course, the exact amount of your withdrawals would depend upon the risk you decide to take on in your portfolio as well as your expected lifespan and other factors. But, I see no reason to not use the 4 percent rule as a starting point in your plan. Some years may be less, some a little more.

Third, be aware that spending in retirement is not linear. Rather, spending tends to be higher in the early phase of retirement, drops off in the middle phase, and then trends higher at the end. This makes sense. The early years are likely when you will want to cross items off your bucket list and address delayed gratification. Not to worry, as the average retiree spending tends to drop off at a real rate of about 1-2 percent a year after the initial splurge, according to data from the Center for Retirement Research at Boston College.

Finally, remember that the average retirement lasts about 8,000 days. It is a long journey, but don't delay in having a lot of fun! If your retirement income plan is in order, go ahead and spend some money. That's what it's there for.

Jonathan Lokken, CIMA is managing principal of Lokken Investment Group LLC in Lewes. He has been professionally managing client investments since 1997. For more information, go to www.lokkeninvest.com or call 302-645-6650.

Disclaimer: The foregoing content reflects the opinions of Lokken Investment Group LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. All investing involves risk. Asset allocation and diversification does not ensure a profit or protect against a loss.