One of the most vital services we provide to our clients is helping them understand how much they spend each month. While it sounds trivial, it is perhaps the most overlooked (and critical) piece of the financial planning puzzle.
When we ask our new clients and prospective clients how much they spend each month, the spending number they give us is almost always at least $2,000 or more per month lower than their actual spending number. One of the main reasons we ask to review our clients’ tax returns is that it enables us to calculate an accurate spending number for that year.
For instance, let’s say a client tells us they spend around $6,000 per month. When we review their tax returns over the span of several years, their spending is more like $8,000 or $9,000 per month. We’re certainly not budget hawks, but a retirement plan that understates a client's spend number by 25-35% isn’t going to be worth a darn to our client.
The chart below demonstrates the correlation between monthly spending and the required retirement portfolio to sustain that spending through a 30 or 35 year retirement. Although most people can easily grasp that such a correlation would exist, we have found it is uncommon for people to truly comprehend the impact that spending has on their retirement plan.
* The calculations assume a 4% withdrawal rate from your portfolio and an 80% replacement rate. That is, the portfolio withdrawals would cover 80% of spending, while Social Security would cover the remaining 20% of spending.
For every additional $1,000 of monthly spending, your required portfolio increases by $240,000.
For our clients that desire an early retirement, this relationship between spending and required nest egg becomes paramount. When a client retires at age 55, our recommendation is that they only withdraw 3% annually from their portfolio. Couple that with the fact that Social Security won’t be starting until age 66 or later (full retirement age, at least), and you realize that keeping spending modest is the best way to ensure your ability to retire at a young age.
What does this mean to you?
One of the core pieces of our advice to clients is to focus on things that you can control. We cannot control the global stock and bond markets; we cannot control geopolitical events and politicians; and we cannot control our spouses or children. But, we have absolute control over how much money we spend each month and how we handle debt.
Through being debt free, living well within our means, and spending money mindfully, we can drastically reduce our required retirement nest egg – and thereby dramatically increase our probability of a stress-free, bountiful retirement.
Because The Wealth Group, Austin B. Colby & Associates is independent of Raymond James, the expressed written opinions above are our own and not necessarily reflective of Raymond James’ opinions.