Sunday, August 16, 2015

Consumption Smoothing and Adjusting Your Frugality Setting

Consumption smoothing is the economic concept used to express the desire of people to have a stable path of consumption throughout their lifetimesThe ideal consumption smoothing case, assuming no bequest motives, is to save just enough during your working years to be able to spend your retirement savings to fund about same lifestyle in your retirement years, and to die broke. Of course since we don't know how long we'll live, or exactly what our expenses will be in retirement, this is a difficult ideal to achieve.

To give yourself a reasonable margin of safety for retirement, you may need to be more frugal in your accumulation years than you want to be. Conversely, if your investment returns were better than expected, or perhaps you were just more frugal than you had to be while working and saving, it might be reasonable to be less frugal in your retirement years than you disciplined yourself to be in your accumulation years. Your consumption smoothing may not end up being ideal, but perhaps it then makes sense to work on overcoming your previously virtuous frugality, and spending more to enjoy your remaining years more.

I see some working people being less frugal than I think is prudent, and this may result in significant reductions in their lifestyles when they retire. They probably need to think more about consumption smoothing. But I also see some retired people being overly frugal after many years of assiduously developing and practicing great savings habits during their accumulation years. Consequently, they may be depriving themselves and perhaps their significant others of the fruits of their many years of working and saving. 

It's hard for most working people to save too much these days, so most of them should be saving as much as they possibly can for retirement. But for those of us who have been frugal, have saved diligently during our accumulation years, and perhaps have achieved good investment returns, it might take some work to shift the frugality gear down a notch or two in retirement.

I've seen more than one Boglehead post about the challenges of shifting from the frugality mentality of the accumulation years to a less frugal mentality, once they've realized that they've accumulated more wealth than they need to last them the rest of their lives. I've had to work on this myself, and it's still a work in progress.

So all of you working folks, please keep saving as much as you can for retirement. For those of us who've spent many years living below our means so that we can ensure a financially secure retirement, let's remind ourselves that we've met our retirement savings goal, and that we might want to work on developing different spending habits, lest we deprive ourselves and our significant others of enjoying our golden years as much as possible.


  1. This certainly is an issue for me. My COLA'd DB pension covers our needs. In the future, we'll add DW's SS and RMD for each of us. i-orp says to spend down our taxable now, but I like having the cushion.

    We both have LTC insurance. We have a year of liquid taxable funds in addition to tax-deferred and Roth. We could easily cut our spending rate. So, how much more do we need for emergencies? I haven't been able to answer that.

    Another BH

  2. 2 post in a row….nice!

    This one hit a nerve for me…..Ran 3 businesses over a 25 year period and somehow limped away after it was all said and done with ~$11M.

    We live in a nice $600k house and spend a little over a $100k per year. Been living like this for a long time, but suspect we could increase our spending a lot if got ok with letting it go to zero about the time we die….

    But somehow it just seems wrong to spend more than we actually naturally "want" to when in the back of our minds we know that whatever we don't consume will go to cancer research in our estate…..

    The only caveat to this is if our overly greedy government figures out a way to tax it all away before it makes it to our estate.

    If that starts to happen, might as well buy the Ferrari!

  3. No need to spend more than you want to spend to live a happy life (you and your significant other, if you have one). And a bequest motive is a reason to continue your frugality as long as it doesn't deprive you and your loved ones from enjoying life now. Or perhaps you are OK with enjoying life less so you can leave more to your favorite charity; more power to you.

    Like I said--I don't need to spend a lot of money to enjoy life, but I also want to think of others in my life. I certainly don't advocate burning through cash unnecessarily, but just maintaining appropriate perspective. Many people should spend less, some people maybe should spend more.