How much money can you spend in retirement? What kind of lifestyle would you like your savings and investments to fund during your golden years? In Fisher Investments UK’s view, the answers to these questions are key to figuring out how to fund retirement with long-term investments (in whole or part). We think there are two broad ways to estimate expected expenses, and both can inform how you fund your retirement. Doing so can help you develop a financial plan based on your unique situation and needs, in our view.
First, we think it is sensible to start estimating your anticipated expenditures. Tally up your current expenses and consider how those might differ in retirement. Separate them into nondiscretionary living expenses (things you must spend on) and discretionary spending (things you can live without). The former may include housing and healthcare costs and other financial obligations, including debt payments, taxes and insurance. The latter is more optional, e.g. travel and entertainment. These are expenses you could curtail in a pinch, if needed. By recording everything you can think of, from expected day-to-day spending to less-frequent or even just potential expenditures, you can get an approximate idea of what retirement will cost—how much it will take to maintain a certain quality of life.
Then, we think it is wise to review how your spending might change, if at all. For instance, will you relocate in retirement? Are living costs in the new area likely to be higher or lower? Also consider expenses you may reduce or even forgo in retirement, including commuting costs, professional clothing or child/elder care that may no longer apply. Alternatively, what could increase? Is there a hobby you always wanted to take up, or do you plan on travelling or dining out more? Don’t forget healthcare. The older you get, the likelier medical expenses are to increase, in our experience. Your family history in this regard may provide a rough guide on what to plan for.
Once you have determined what you will be spending on, we also think it is important to factor in inflation—i.e. the general rise in prices across the whole economy. Besides your country’s historical inflation rate and trend, we think it helps to review price increases in spending categories relevant to your personal situation. For example, between 2001 and 2020, eurozone prices for hospital services rose 64.6%, greatly outpacing the broad Harmonised Index of Consumer Prices’ 35.1%.[i] (The Harmonised Index of Consumer Prices, or HICP, is a broad measure of goods and services prices.) It was even more dramatic in the UK: Hospital-services prices rose 161.0% versus HICP’s 46.0% over the same time frame.[ii] We think these types of trends are worth keeping in mind for investors approaching or already in retirement. Whilst your projections don’t have to be exact, tracking your personal inflation rate over time can help reduce the likelihood of surprise as your costs of living increase later in life. Factoring in inflation can also let you work in a cushion for it in your retirement plan.
After establishing what is leaving your pocketbook, what do you have coming in? This amounts to your expected noninvestment income in retirement plus the cash flow your portfolio can generate. Noninvestment income may include state and private pension schemes you qualify for, residual business income and income earned by a family member or yourself (e.g. for part-time work taken up in retirement). We think comparing this with your likely expenses can give you a clearer picture of what your investments need to accomplish—and what kind of portfolio withdrawal rate is sustainable in your situation.
This review can help set the upper bound of your spending over a given time period under differing circumstances and conditions. In our view, this depends critically on your time horizon—the period you (and your loved ones) need your investments for—which we think depends generally on your health, life expectancy and any legacy you would like to leave. From here, we think it is beneficial to take into account various asset-return projections—using history as a guide to set realistic assumptions—and your comfort level with market risks. Going through this exercise can help you form reasonable expectations about what your retirement portfolio can—and cannot—provide. If the budget you selected in the first half of this exercise results in large withdrawals from your investments that could drain your accounts whilst you still need them, you may find it is a helpful signal to alter your plans, perhaps by saving and investing more before you retire or reducing your planned expenses. It is also helpful to keep the nondiscretionary versus discretionary expense divide in mind, in Fisher Investments’ UK’s view. In the event of adverse market conditions, reducing discretionary spending can help. Hopefully you never need to do that. But it is possible.
In our view, exploring the interplay between likely expenses and cash flow creates a useful foundation for financial planning. Early in the retirement-planning process, you can use your estimated personal spending rate to back into savings and investment targets to fund desired withdrawals. This can inform how much you need to save and your asset allocation—your portfolio’s mix of shares, fixed interest, cash and other securities. Establishing a long-term financial goal during your working years can help you plan whilst also accounting for potential adjustments along the way. Closer to—or in—retirement, you can use your nest egg and prospective withdrawal rates from it to help guide your spending decisions. Not everything goes to plan, but we think setting some basic expectations can help you better prepare if things don’t quite work out as you initially envisioned.
In our view, retirement budgeting isn’t set in stone. We think it should be a continual process, reviewed periodically and updated as circumstances change.
Interested in planning for your retirement? Get our ongoing insights, starting with The Definitive Guide to Retirement Income.
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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.