One of the biggest mistakes retirees make is to underspend in their retirement. Retirement is full of uncertainties, so the safest strategy is to spend as little as possible. There is nothing wrong with that approach if you don’t mind going without for the benefit of your children. However, most retirees these days are happy if their children inherit the house and whatever money is left after their own needs have been met. The way to avoid underspending is to reduce the financial uncertainties that lie ahead. There are three big uncertainties:
- How much money will I need?
- What will my investment returns be?
- How long will I live?
Longevity is difficult to predict and the most positive approach is to assume you are going to live a long time. For people who reach 65, life expectancy is around 90 and increasing, however, many people are retiring later than 65. On average you can expect to live between 25 and 30 years in retirement. Finances should be planned accordingly. Break these years down into three periods of 8-10 years and allocate your available funds between these periods.
For each period, you will need money to cover day to day living expenses and money for big, one-off expenses such as replacing your car, taking overseas holidays, maintaining your home or covering health-related costs such as hearing aids and dentistry. As you get older, your spending patterns will change and you will probably spend less. Within each of the three time periods, the amount you can spend will be limited by what you have allocated to that period and the investment returns you receive.
The more detailed you can make your expenditure plans, the less uncertainty you will face and the less likely it will be that you will underspend.