Oblivious Investor

In a recent paper, David Blanchett found (again) that household spending tends to decrease over the course of retirement. That is, it increases, but not as quickly as inflation. So in “real” terms, it’s gradually going down.

Relative to Blanchett’s earlier work on how retirees change their spending over time, his latest paper had two particularly noteworthy findings.

Median vs Mean

The first especially interesting finding was the difference between the median and mean (average).

For the median retiree, inflation-adjusted spending decreases throughout retirement.

For the average (mean) retiree, however, inflation adjusted spending goes back up at older ages (though it still stays below the initial level of spending).

The difference appears to be significantly due to large health-related costs at older ages, which are included when calculating a mean, but which do not affect the median retiree. For example, as Blanchett writes, “among those who passed away at the age of 95, the median cumulative real lifetime unexpected out-of-pocket medical expenses were only about $50,000 compared to roughly $250,000 at the 95th percentile.”

Reducing Spending by Choice

The second particularly interesting finding is that even households that are “funded or overfunded” still reduce spending. That is, while some retiree households reduce their spending due to limited funds, even households who don’t need to reduce spending nonetheless typically do still reduce spending over time.

As Blanchett writes, “Only those respondents who were the most well-funded and spending at lower levels tended to increase in spending. Average real spending declined for all respondents spending $80,000 or more, regardless of funded status, although spending declines were lower as funded status tended to improve.”

Why People Reduce Spending

To me, it’s not surprising at all to find that people reduce spending over their retirement, even when they aren’t forced to do so.

For example, imagine a world in which there was absolutely no uncertainty. You know exactly what your career earnings and investment returns will be. You know what inflation is going to be. You know exactly how long you (and your spouse, if applicable) will live. You know exactly what your health care costs (and other “lumpy” costs such as home repairs) will be each year.

And so you’re left with some, definitively known, amount of discretionary spending, which you can allocate across the years of your life.

In that world, how would you allocate those dollars, across time?

There’s no right or wrong answer here. But most people would choose to do more discretionary spending in their earlier years and less in their later years, simply because it’s easier to enjoy discretionary spending at a younger age. At 25 it’s easier to have a travel-the-world type of adventure than at 45. It’s easier at 45 than at 65. And it’s easier at 65 than at 85. And the same things goes for most types of discretionary spending. It’s just easier to do it the younger we are.

Some people might choose the classical economics “consumption smoothing” idea of having your spending stay level over time. But it’s hard to imagine many people intentionally choosing an increasing spending path all the way through life (e.g., pinching pennies at age 35 so that you can “live large” at age 85).

Now let’s bring back one type of uncertainty: lifespan. So we’re still assuming no investment risk, no uncertainty as to health care costs or other big expenses. But now we don’t know how long you’ll live. Naturally, that means we need to plan for a scenario where you live longer than your life expectancy, but there’s another aspect here that is often left out. And that is: would you weight earlier years more heavily (i.e., choose to spend more in those years than in the above case) simply because you know you’ll be alive in those years? In other words, separate from the decision you made above about year-by-year spending preferences, when we add longevity uncertainty into the mix, would you now choose to, for example, further shift the spending in the direction of the earlier years, simply because you’re more likely to be alive during those years?

Again, different people will answer differently here. But this factor is either not important to you, or it’s a point in favor of more spending in earlier years. Nobody would say, “I’m less likely to be alive at age 95 than at age 65, and therefore I will plan to allocate more dollars to spending at age 95 than at age 65.”

So we have two factors, both of which point in favor of weighting earlier spending more heavily than later spending (though to differing degrees from one person to another). For most households, that’s broadly the goal that we’re trying to achieve.

“Reducing spending throughout retirement” might sound bad. (And indeed, being forced to do so is probably not what we want.) But “intentionally choosing to spend more in earlier retirement” is another way of saying the same thing, and it is broadly something that people want to do.