Your clients need to shift financial gears as they enter their sunset years
Habits are powerful mental tools. Once you identify a helpful routine and repeat it enough times, it gets carved deep into your mind. You do it without thinking about it.
But what happens when those routines don’t work like they used to?
In a piece contributed to the Wall Street Journal, finance professor Dr. Meir Statman says that people entering retirement often face that problem. Certain financial habits and attitudes that helped them during their working years may not be so useful when it’s time for them to enjoy and take care of themselves.
One example is the tendency to be conscientious. “Conscientious people accumulate more wealth than less conscientious people, even after accounting for differences in income, education and cognitive ability,” says Statman, who teaches at Santa Clara University’s Leavey School of Business in the US. But during retirement, that mindset keeps people with enough money to enjoy life from actually spending their hard-earned wealth.
Then there’s the habit of spending income without touching capital. Consider a 65-year-old with a US$1-million stock portfolio who needs to spend US$40,000 a year (on top of expenses covered by pension benefits). Assuming the portfolio earns US$20,000 yearly in dividends and another US$20,000 in capital gains (taking fees and taxes into account), it would be enough.
But many retirees can’t bear to touch their stocks. As a result, they spend below their capacity or get into higher-risk investments even if they don’t need to.
Statman says retirees also tend to overestimate their longevity. According to him, 68-year-old men have a 71% chance of reaching 78, but they estimate their chances to be 82%. That thinking makes retirees more likely to scrimp excessively. “I’m not suggesting people spend every penny they have by age 95,” he says. “But most people have a lot more leeway to spend than they realize.”
The tendency to delay gratification could also work against retired people. While it can be prudent to put off consumption or luxury expenses, like travel, people become less capable of spending money for such things as they get older and weaker.
Retirees should also accept that their financial priorities should change with age. Saving a few hundred dollars flying coach may have been worth it when they were young and trying to save. But in the decumulation phase, retirees should consider putting a higher premium on comfort and convenience instead of focusing on cost.
What about bequeathing their estate? Statman suggests that retirees are too hung up on the idea that they shouldn’t give at all until after they pass on. As an example, he talked about a couple who gave their son a loan for him to go to law school. The son is starting his career and building a family, and the father asked whether he should forgive the debt. The couple can easily afford to not collect it, and the son stands to inherit money from them anyway.
“Why, I asked, would they insist on having him pay it back now, when he probably needs it the most, and they could enjoy the act of giving it the most?”
Finally, Statman says retirees should resist the temptation to manage their own investment portfolio. Even if they think they have time to learn how, there’s too much downside risk. If they lose their money, it’ll be hard, if not impossible, to get back.
“As an old commercial advised, you don’t have time to earn it anymore,” Statman said.
For more of Wealth Professional's latest industry news, click here.
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But what happens when those routines don’t work like they used to?
In a piece contributed to the Wall Street Journal, finance professor Dr. Meir Statman says that people entering retirement often face that problem. Certain financial habits and attitudes that helped them during their working years may not be so useful when it’s time for them to enjoy and take care of themselves.
One example is the tendency to be conscientious. “Conscientious people accumulate more wealth than less conscientious people, even after accounting for differences in income, education and cognitive ability,” says Statman, who teaches at Santa Clara University’s Leavey School of Business in the US. But during retirement, that mindset keeps people with enough money to enjoy life from actually spending their hard-earned wealth.
Then there’s the habit of spending income without touching capital. Consider a 65-year-old with a US$1-million stock portfolio who needs to spend US$40,000 a year (on top of expenses covered by pension benefits). Assuming the portfolio earns US$20,000 yearly in dividends and another US$20,000 in capital gains (taking fees and taxes into account), it would be enough.
But many retirees can’t bear to touch their stocks. As a result, they spend below their capacity or get into higher-risk investments even if they don’t need to.
Statman says retirees also tend to overestimate their longevity. According to him, 68-year-old men have a 71% chance of reaching 78, but they estimate their chances to be 82%. That thinking makes retirees more likely to scrimp excessively. “I’m not suggesting people spend every penny they have by age 95,” he says. “But most people have a lot more leeway to spend than they realize.”
The tendency to delay gratification could also work against retired people. While it can be prudent to put off consumption or luxury expenses, like travel, people become less capable of spending money for such things as they get older and weaker.
Retirees should also accept that their financial priorities should change with age. Saving a few hundred dollars flying coach may have been worth it when they were young and trying to save. But in the decumulation phase, retirees should consider putting a higher premium on comfort and convenience instead of focusing on cost.
What about bequeathing their estate? Statman suggests that retirees are too hung up on the idea that they shouldn’t give at all until after they pass on. As an example, he talked about a couple who gave their son a loan for him to go to law school. The son is starting his career and building a family, and the father asked whether he should forgive the debt. The couple can easily afford to not collect it, and the son stands to inherit money from them anyway.
“Why, I asked, would they insist on having him pay it back now, when he probably needs it the most, and they could enjoy the act of giving it the most?”
Finally, Statman says retirees should resist the temptation to manage their own investment portfolio. Even if they think they have time to learn how, there’s too much downside risk. If they lose their money, it’ll be hard, if not impossible, to get back.
“As an old commercial advised, you don’t have time to earn it anymore,” Statman said.
For more of Wealth Professional's latest industry news, click here.
Related stories:
OSC releases behavioural insights report
Why it’s important to remove emotion from your clients’ decisions
