Posted by Tim Stobbs on January 10, 2017
As many of you already know I have a very optimized plan when it comes to us spending our money each year. I don’t spend more than I have to on my water bill, we borrow books from the library prior to buying them and will gladly spend money on buying a wine kit to brew at home instead of buying a bottle from the store. Over all this results in us having a very good life on far less than most people would for a similar lifestyle. Our spending is highly optimized to our particular wants and needs.
So for years I’ve generally considered optimized spending a strength of our plan after all when you are reducing your spending the you have more money for savings each month and you also can reduce your overall retirement goal. For example, if you need $1 million to retire with a $40,000 per year expenses, if you drop your expenses to $30,000 you only need $750,000. So you don’t have to save that extra $250,000 in the first place. I always considered this a good thing.
Except when it isn’t. Oddly enough I came across the idea it can also be a weakness to your retirement plan. Which I thought was a bit silly at first until I realized what they were getting at (sorry I don’t recall where I read this or I would link back to the source). Having overly optimized spending also means you don’t have much fat in your budget to cut as the core spending (like your property taxes, home heating, power or water) takes up a greater percentage of your overall budget. It also means any jumps in those core expense have greater impact on your budget as you have less optional spending elsewhere that you can cut to cover it. After all, when you are overly optimized you already cut most of the optional spending out years ago.
So let’s compare two cases to demonstrate this: let’s say family A is spending $40,000 a year and they retire with $1 million saved. Then the stock market drops 40% and inflation spikes so their core spending goes up $1000 per year. So being reasonable people they look to cut $1000 per year out of their spending (or 2.5% of their yearly budget) and they go after a few things they haven’t optimized before and make up the difference. Then we have family B with $30,000 a year spending and only $750,000 saved. They have the same event and $1000/year increase in core spending from inflation. Now they have less to cut in the first place and they have the added bonus of the increase being a higher percent of their spending at 3.3% of their yearly budget. Over all family B’s ability to cut spending is more limited and the increased core spending dollar amount has a greater impact overall.
Hence the point that overly optimized spending can also be a weakness during your early retirement beyond being a help to get you their sooner. So how do you deal with this issue? Well me personally I don’t plan on changing my plan because of this, but I would suggest the idea of making sure you do have some buffer in your budget. You might not really need that buffer most of the time, but even if you don’t use it initially that extra money could be spent on a one off event later on if you aren’t using the buffer. For example, take an extra trip every five years if you aren’t using that buffer amount. The size of that buffer is a personal choice and will shift with how much slack you have in your overall budget. The more optional spending you have, the less buffer you may need and vice versa.
So do you have overly optimized spending? What would you do to resolve the risk of higher inflation and a lower market?