“I have enough money to last me the rest of my life, unless I buy something.”
I recently wrote that budgeting when you’re working is an opportunity to practice living within your means so that when you hit retirement, you’ll be prepared. After all, if you miss your budget when you’re working, you still have the opportunity to make up the lost savings because you can work another year or three – though relying on working until you’re older isn’t a surefire bet – or you can earn more during your working years to cover the shortfall.
If you’re like many of my readers, that article felt like it was bordering on the harping over minute, de minimis numbers. Pretty soon, it could stand to reason, I’d be telling you to reuse coffee grounds two or three times when making pots of coffee (like I did when I was in college).
For some reason, the watch every penny advice reminds me of an old commander I had in the Army. His motto was “a unit that looks good fights good.” I should have known that someone who employed improper grammar wasn’t going to be the next Patton or Guderian. Indeed, that was the case. His units’ vehicles all were sparkling and spotless going into a field exercise, and they got blown off the battlefield by the enemy forces. It made me glad that we weren’t going into a real war. As a friend of mine once said, “You can’t shine a turd.”
In fact, I specifically called out missing a $4,500 budget by $200 as a potentially big deal. To wit, I said:
If you miss by $200 out of a $4,500 budget, spending $4,700, you think to yourself that it’s not a big deal because $200 is such a small proportion of $4,500.
YOU: “Yikes. We went over in the budget this month by $200.”
MONKEY BRAIN: “$200 ONLY 4.4% OF $4,500. ROUNDING ERROR. NO WORRY. GO SHOPPING.”
YOU: “Good point! Thanks!”
Am I making much ado about nothing?
Let’s see how much that 4.44% error in budgeting and spending plays itself out both when you’re in your earning years and when you’re in your retirement years.
To set this up, let’s first make some assumptions about a hypothetical couple.
This hypothetical couple makes $5,396.98 per month. Why that number? Because, according to Dr. Wade Pfau’s SAFEMIN calculations, to be able to live for 30 years in retirement using a 4% safe withdrawal rate and assuming that 50% of the spending is accounted for by Social Security, you need to save 16.62% of your income in the previous 30 years investing in a 60/40 split of stocks and bonds. So, they live on $4,500 per month when they hit their budget. Their paychecks and expenses are tied to inflation, so the budget miss is 4.4%.
We’ll assume that this family invests in the S&P 500 for stocks and in the AAA corporate bond index for bonds and use historical returns to simulate a world of possibilities for them. We will also use historical inflation numbers to create a set of potential inflation scenarios as well.
After 30 years, this couple will retire and live for another 30. They’ll need $4,500 per month to live on, adjusted for inflation, meaning that if they need $4,500 a month now, they’ll probably need much more than that when they retire, and Social Security will only cover half of their living expenses. They’ll need to tap into their savings for the rest.
I examined three scenarios and conducted 10,000 Monte Carlo simulations to evaluate how each scenario played out. A Monte Carlo simulation uses random number generation to predict a range of futures. Since we know that the future won’t look like the past, we use Monte Carlo simulations to generate a range of potential futures.
What did those futures look like?