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Consumption and Lifestyle - the Fulcrum

Jim Williams

One of the most pertinent subjects that we address in the practice of financial planning is lifestyle (level of spending, primarily on consumption). It is of central importance to the planning process since the relationship between spending and resources available is the ultimate key to long-term financial security. At a fundamental level, savings is the difference between what we produce and what we consume; assuming the production is greater than the consumption. We are fortunate to live in a time and place where it is reasonable to expect to be able produce much more than we consume and to save for the future and help others.

During the accumulation phase of life, the dynamic looks like this: The less you spend, the more you save. Consider that when money comes in it can go one of three places: taxes, consumption, or savings. After taxes, savings is everything not spent. Less spent, that is, a lower consumption level means more savings, and a lower consumption level during accumulation probably means a lower consumption level during decumulation (retirement), which means better long- term security. Maintaining a modest consumption rate throughout your life is probably the most powerful financial leverage you can have. Conversely, a high- dollar, high-consumption lifestyle leaves little room to save, and is much more difficult to maintain in retirement, and much more likely to cause the lifestyle to crash in retirement.

Not everyone has the explicit desire for "as much lifestyle as I can afford". We know folks who live well within (below) their means. This is a powerful point of financial resilience. Having some (favorable) margin between what you could spend and what you do spend is an affirmative way of protecting against the inevitable bumps in the road. Having a modest consumption level gives you choices and alternatives.

During decumulation (withdrawal rather than saving), the dynamic is less straightforward but still fairly simple: Outflows equal taxes plus spending. Withdrawals (from the asset base) are the difference between income (Social Security, Pensions, earnings and the like) and outflows. Note that Required Minimum Distributions (RMDs) from retirement accounts are not really "income". Although taxable, they are essentially transfers from one account to the other. There is no requirement that RMDs be spent, although they create a tax liability. So, withdrawals are driven by spending, offset by income. More spending, more withdrawals. Withdrawals are the fulcrum in retirement security mechanics. The arithmetic of withdrawals in retirement security is this: Expected net total return of the portfolio less withdrawal percentage is the impact, positive or negative on the portfolio. For example: if your expected return net of fees is, say 6%, and your withdrawal rate is 4%. That leaves about a 2% growth rate to keep up with inflation. If your expected return is 6% and your withdrawal rate is 7%, you will be diminishing your portfolio by about 1% per year on average.

Markets have been pretty generous lately. We always caution our clients that this, too, will end. There will be a correction/downturn/other-negative-market-event. We do not know when or how much. From an investment standpoint, our advice is the same regardless of the cause/severity/duration: sit through it. You will lose if you try to navigate around the pain: it is almost certain that you will be worse off.

What about lifestyle when the downturn happens? Well, if your fixed burn rate is pretty much everything you can afford to spend while things are good, what will that look like when things are not so good? Sell a(the) house? Remember the housing market in 2008 - 2009? Lots of really nice houses sat on the market for a long- long time. If you find yourself in the position of having to sell to meet expenses, and you are the motivated one in the transaction, you may realize a good bit less for the second home than you are thinking about today.

We also see that often, lifestyle is very wrapped up in the social standing one enjoys. This is where spending is wrapped up in the need to reflect back the consumption badges of the social circle one is seeking to maintain. This can be an immensely powerful motivator. Perhaps the best immunization to this spending bent is a healthy dose of not caring what the Joneses do or don't do.

The "everything we can afford" standard during good times, may have two pretty likely of many possible consequences: 1) make the adjustment to a downturn much more painful and/or 2) if no adjustment is made in the downturn, a much heavier withdrawal rate jeopardizing the long-term viability of the asset base. Now, the point can be made that folks want to "enjoy it when they can", and that certainly makes sense, up to a point. But how to balance these competing desires? Read on.

Now, it is true that most of us do not want to end our lives with a big wad of money and would prefer to enjoy our resources during our lives. That means we will, at some point turn to a net withdrawal phase where the withdrawals exceed portfolio earnings. Where in the time horizon this occurs can vary widely, but it ultimately turns on health and longevity. If the choice here is between having financial security late in life with or without good health, we think the default premise is that it would be better to have some resources even if health is poor than it would be to have severely limited resources whether-or-not in good health. We all can have different views on this trade-off.

However, we think it is easier and more comfortable to adjust up to a higher standard occasionally when times are good than it is to adjust down from a high standard when times are not so good.

We urge that the best approach is to start with your own sets of values and preferences, well stated and all together as much as possible. This can be the foundation for a set of policies related to all the primary facets of your life. You can identify not only income goals, but spending categories such as charitable, education, travel, and on and on, as well as financial security goals for older age and goals for the estate. The purpose of the exercise is to aggregate these goals into a unified financial plan that allows you to balance lifestyle (consumption, charitable, etc.) against future security.

This process can be pretty tedious and yet very clarifying. After all, how else might one balance their current consumption spending against their need for security in old age. You need to look at them together and weigh them out. This is not a set of decisions that can be well-considered in a seat-of-the-pants mode.

We are here to help you with this.

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The table below shows the returns through September 30, 2018 for selected investment asset classes. In most cases, the results below are appropriate benchmarks for the related mutual funds in your investment portfolio.