In planning for retiring clients, it's crucial to get an understanding of what the client's goals are in the first place so that recommendations can be made about how to financially secure those goals.
In the context of setting a spending goal, a popular delineation is to separate retirement spending into "essential" versus "discretionary" expenses—not unlike "needs" versus "wants" for accumulators—with the idea of using guarantees to secure the essential expenses, and less certain growth assets with some risk to fund the discretionary expenses (since they're "only" discretionary and not essential, by definition).
Yet in reality, even discretionary spending still constitutes an important part of a retiree's overall lifestyle, the loss of which could be very psychologically damaging. As a result, merely securing the essential expenses of retirement and leaving the rest at risk still, in the eyes of most retirees, would constitute a failure of the overall retirement goal.
Instead, clients often choose to ensure that all their spending can be sustained—by continuing to work as long as necessary (as health allows) to secure all of their goals. Does that mean the distinction between essential and discretionary retirement expenses isn't necessarily helpful after all?
The inspiration for today's blog post was a recent discussion I had with a retirement researcher with AARP regarding the "essentials vs. discretionary" approach to retirement planning, where spending needs are separated into two categories, each of which may have their own funding and investment strategies. Yet in practice, the approach can be more problematic than its simple elegance suggests. To understand why, it's necessary to understand the basic "wants vs. needs" framework upon which it is built.
Wants vs. Needs
In most ways, the separation of essential and discretionary retirement spending is not unlike the separation of wants and needs for any individual's general levels of spending. As the theory goes, there are basic needs that everyone has—food, shelter and clothing—but no matter how much we really think we need it, an iPad is not really a "need" but is simply a want.
In fact, even within the classic need categories of food, shelter and clothing, there are still wants. For instance, while we need clothing, we don't need fancy designer clothes; similarly, while we need shelter, we don't need to have an apartment to ourselves when roommates will do, or a huge 5,000-square-foot house when 1,500 square feet would still be more than enough to provide a roof over our heads. This framework can be highly effective in helping people to establish appropriate spending behaviors. Where there is no clear delineation between needs and wants, it becomes difficult to control impulse purchases and make rational spending decisions. When there's no difference between needs and wants, the only constraint to spending is the amount of money available to spend—leading to the unfortunate outcome where spending on needs and wants-as-needs rises to fill all the available income until there's simply no money left at the end of every month (or potentially not even enough money to make it to the end of the month!).
