Planning Your Expenses in Stages

Jonathan Clements in the Wall Street Journal explains four useful strategies for retirees to avoid running out of money. I found the third strategy “segmenting the problem” quite interesting:

Many seniors loathe the idea of delaying Social Security and they don’t like income annuities. As an alternative, think of your retirement in five-year segments.

Let’s say you quit the work force at age 65 and you can’t imagine living beyond 90. You might divide your portfolio into five buckets, to cover your spending from age 65 to 69, 70 to 74, 75 to 79, 80 to 84 and 85 and beyond. Vary the amount invested in each bucket, depending on how much you expect to spend and what after-inflation investment return you think you will earn in the meantime. This strategy will provide some predictability. After all, as you cash in each bucket, you will know how much money you have at your disposal for the next five years.

I like the idea of breaking the problem down into small steps and think that it can be useful at any stage of life.

A new college graduate could plan for three “buckets”: age 21 to 30 (paying off debt and building a career), 31 to 64 (buying a house and starting a family), and 65 and beyond (enjoying retirement). This formulation is similar to the one I discussed in my introductory mechanism design post where I explained why it makes sense to save for retirement before spending on yourself today.

And yes, I made large age buckets for the young person. But thinking more specifically would be difficult. College graduates have a hard time knowing where they will be in ten years. I certainly had no idea.