When planning their retirement savings, most people follow one of these patterns:
- No retirement savings or hardly any.
- Haphazard savings with no planning.
- Fixed savings each month.
- Saving a fixed percentage of their income.
Do any of these sound like what you do? If so I’d like to introduce you to a better approach.
What’s wrong with a retirement savings plan?
If you’re saving for specific expenditure, like a new car, then there’s nothing wrong with using a savings plan. It will help you work out how long it will take to reach your target sum.
But retirement savings are completely different. If your focus was on savings then your thought process might be something like:
- Decide what income you want in retirement, and when.
- Calculate how much savings you need to generate that income.
- Plan a savings schedule that reaches your target amount.
There are a number of problems with this approach:
- Deciding what income you need in retirement is a hard problem. I wrote about this in my post on the 80% rule.
- Calculating how much savings you need to generate giving income is also a hard problem. I wrote about this in my post on the 4% rule.
- After you’ve put away your savings, by definition you’d spend the rest. How do you make sure that your available discretionary spending before retirement isn’t wildly different from what it will be after retirement? If you under-spend before retirement, you might not live to enjoy your savings. If you over-spend before retirement, then you’ll feel poorer afterwards.
Focus on spending rather than on savings
There’s a better approach to retirement savings, and that’s to shift your focus on what you spend instead. Broadly there are two kinds of spending: essential and discretionary. Essential spending isn’t as fixed as the name implies. A rich person will have higher ‘essential’ spending than a poor person. What counts as essential spending is in the mind of the spender.
Once you’ve determined what you consider to be essential spending, any other spending is discretionary. In theory the ideal pattern for discretionary spending is that it should remain constant year in, year out. It should be adjusted each year for inflation but it should otherwise be roughly constant. That way you avoid any sudden shocks when you suddenly feel poorer. You also avoid sudden increases in spending by ‘blowing it’.
This type of smooth consumption is very hard to achieve if your focus is on savings. But if you focus on spending the question becomes:
- What’s my sustainable level of discretionary spending?
Once you know the answer to this question, then your savings plan becomes incredibly simple:
- Save whatever you don’t spend.
How do you work out your sustainable discretionary spending?
Fortunately EvolveMyRetirement has created an app that does this for you. We call it the Intelligent Financial Planning Calculator, because it uses an AI technique to optimise your discretionary spending. At the same time it optimises other factors that help your planning be effective.
Instead of telling you whether or not your plan will run out of money, the EvolveMyRetirement app helps put you onto the right track in order to avoid it.