Joyful Budgeting in Retirement: Our Easy Solution

There’s not a fellow retiree I know of who doesn’t think about how to balance spending and conserving their wealth. Jon and I go through a very specific process, developed over years, for each major spending decision. We thought we would share our process with you since it has allowed us to live our dreams now and feel confident that we will continue to conserve enough money to live our dreams for years to come.

Here’s how we maintain abundance while using our financial resources in a way that creates joy for us in retirement. Indeed, we want to 

• spend without trepidation, 
• to have a solid understanding of our spending habits and flexibility, 
• and to sleep soundly each night knowing that we are spending in a very responsible way. 

In other words, we’re happy about our spending and it gives us joy to think about the ways that we’re spending our money. We work with a certified financial planner to achieve these goals and recommend that you consider doing the same.

How We Feel Secure: Our Portfolio and Lifestyle Cushions

Our personal strategy to optimize our spending given our retirement income each year is to create portfolio and lifestyle cushions. A portfolio cushion means that we keep a little extra cash in our investment portfolio beyond how we project that the investments will grow (more on that below). A lifestyle cushion means that we have a list of things that we spend money on and enjoy but that we know we can do without if the economy declines (like getting hit with a worldwide pandemic).  

When we reach age 65, our retirement income stream will consist of a pension, social security, and distributions from our investment portfolio. We’re in our late 50’s now so, at this time, our income stream is entirely from our investment portfolio. Spending in retirement is all about the balance between how your investments grow and what you take out of your investments to live on and enjoy. 

If you have a financial advisor (or decide to get one soon), the idea of maximum annual portfolio withdrawals and ideal portfolio allocations (e.g. x% equities, bonds, etc) is or will be part of your lexicon. Those terms simply describe the balance between how your investments grow and what you take out of your investments to live on and enjoy that I mentioned above. 

One strategy is to just transfer 4% of the investment portfolio balance to our checking account each year as our annual budget. The reason 4% is chosen is that it is an estimate of minimum investment growth. 

Creating the Portfolio Cushion

However, in a bull market of 14-20% gains, we may be able to grow our investment portfolio beyond our projections as well as spend a little more. It’s a balance between creating a portfolio cushion and having more fun. If we only take 4%, we’ll continue to amass more money for later, but we’ll be foregoing spending on enjoyable activities now during our active, healthy years. More on this balance in a minute.

There are three factors that play into our decision-making about how much to withdraw from our investments. They are:

• We have a pension that kicks in at age 65
• We will both earn social security that we will delay drawing on until age 70
• We are not concerned about leaving an inheritance

From our perspective, it’s acceptable to use a slow decline strategy for our investment portfolio. 

So here’s how we decided to draw down our money. When we first began exploring the idea of early retirement (ages 56 and 57), we created a spreadsheet to predict how much we could spend. (Note: Our financial advisor could have done this for us, but we wanted to explore a number of options and didn’t want to pay for his time that way). We used an annual 4% growth and 7% withdrawal formula based on the value of our investment portfolio on January 1 each year with a simple math approach ignoring month on month investment growth. This method is fairly unsophisticated. Quicken or another program will do this for you with much greater accuracy, but this is what we did to understand our situation better.  For example, the following table uses a base of $1 million to show how to use this strategy to project spending and end-of-year balances:

With these projections, we were comfortable with the predicted value of our account at age 70 at which time we would begin supplementing our annual income with social security and a pension. The table is important in helping us determine how much we can spend each year. Rather than sticking rigidly to a 7% withdrawal, we now look at the projected balance and aim for that target + an investment portfolio cushion of about $50,000. Why a cushion? Because as our financial advisor reminds us, some years may not return even 4%. If a recession occurs, we could even lose money in our account. Therefore, we build in a cushion to the spend-down threshold. 

In summary, this strategy is incredibly simplistic, but it allows us to compare our balance to projected amounts which, in turn, provides a measure of how well we’re doing with regard to the balance between growth and spending. Other much more sophisticated analyses and computer programs are available to give you much more detailed projections. But in the end, you are still making educated guesses about expenses and returns. So don’t let any tool make you too rigid in your spending or saving.

Creating a Lifestyle Cushion

Another way for us to feel confident in our spending is the identification of ways to scale back any time we see a decline in our investment portfolio growth. This is what we call creating a lifestyle cushion. This cushion allows us to pull back to a more austere spending pattern if our investments are not growing as projected for a particular year. The lifestyle cushion involves discretionary spending. We keep our fixed expenses (mortgage, car, utilities, groceries, etc) well within our means such that we can readily afford them if economic conditions worsen and we need to scale back to a 7% or 4% withdrawal rate. Examples of lifestyle cushion spending include

• Dining out
• Business class air travel
• First class rail travel
• Spa treatments (massages, hair color, pedicures, manicures, etc)
• Premier lodging while traveling
• Personal trainer and gym membership
• Shows, movies, and other entertainment
• New clothes
• Home improvements and upgrades
• Home services, such as housekeeping and landscaping

If our investments are doing well, we spend on all of the above niceties. With a roaring bull market, we were able to take out distributions of about 10% of our portfolio annually over the past two years since we retired. Spending the extra 3% over our initial projections allowed us to supplement our monthly spending on extensive European travels in a style that was very comfortable for us. Our investment balance has not fallen below projections and we have enjoyed lots of travel, home renovations, and other spending extras. Even with the extras, we have a healthy cushion to our projected year-end balance. Most importantly, we spend confidently, with joy, and with no worries about whether or not we can afford our lifestyle. 

This is how we think about the balance between spending and conserving our wealth. It is a process that has worked for us and is just one of many ways that you can feel absolutely comfortable and confident in creating joy in retirement. Live your dreams now with the assurance that you will be able to do so for years to come as well.

Disclaimer: We’re not financial advisors/experts. You should consult with your own financial advisor throughout your retirement years on a regular basis to continue to create and enjoy your wealth.