Consider this. Your friend gifts you a box of assorted Danish cookies. Will you have your favourite cookie first or will you save it for the end? In this article, we draw lessons from cookie management to discuss how you should manage spending during your retirement!
Retirement logic
Recall the last time you went on a vacation. Were you more excited in the week leading to your vacation or during the vacation? In most cases, looking forward to a vacation is often more exciting than the vacation itself! Likewise, saving your favourite cookie for the last can sometimes be more rewarding than having it first. Why?
Your happiness is based on the change in the level of pleasure you experience. Having your least-preferred cookie first and the second least-preferred next, and so on, increases your pleasure over time. So, having your favourite cookie last can help increase your pleasure. This insight can help you understand how to manage your retirement spending! How?
You can spend more during the early years of your retirement or in the later years. Now, eating your favourite cookie last may give you more happiness. But this logic may not work well with your retirement spending decisions.
You should consider spending more in the initial years and reduce your expenses as you age to increase your happiness. Why?
The primary reason is the time horizon for your retirement income portfolio.
Unlike other life goals such as buying a house or funding children’s education, your retirement does not have a fixed time horizon.
The retirement income portfolio has to generate steady stream of cash flows till you live. So, you may feel nervous spending more during your early years.
What if you run out of money in your later years? But spending more in the later years may not be all that practical because you may not be physically motivated to enjoy life in your later years.
Managing spending
It is, therefore, behaviourally optimal to spend more during your initial years of retirement and reduce spending in the later years. If you retire at 60, you may want to spend more during the first 10 years of your retired life and reduce spending thereafter. How can you do that?
For one, front-load your leisure spending. That is, your spending on leisure should be more during the first 5-10 years of your retired life when you are healthy and excited about your retirement.
Secondly, your living expenses will reduce as you age. So, spend more on lifestyle during the first 5-10 years of your retired life. Of course, your health-care costs can increase as you age. But you are unlikely to draw lessons from cookie management for your health-care spending; for health-care costs, unlike living and leisure expenses, cannot be planned.
The question is: How should you set-up your retirement income portfolio that allows you to spend more during the initial years of your retired life? You should create term bank deposits to meet your leisure expenses, with the maturity of the deposits matching with the time horizon of your goals.
You can create monthly income deposits for your regular living expenses. And then dip into your contingency fund to spend additional amount each year during the first 5-10 years of your retirement.
Remaining amount in the contingency fund can be considered as a legacy portfolio to be passed on to your children after your lifetime.
The writer is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in
