Last week I was reading the “Wall Street Journal” and ran across a fascinating article called “How to Get More Pleasure Out of Retirement Spending” (Monday, Sept 12, 2016, Section R1, Front Page). The author of the article came home from a business trip with a box of chocolate truffles for his 6-year-old daughter. When he gave her the box she decided she would only eat one chocolate per day, starting with her LEAST favorite one.
I thought that was a pretty admirable approach for anybody, but especially for a 6-year-old. In effect, she decided to defer gratification so that every day would be better than the previous (well, at least better in that each day she ate a chocolate that she liked better than the previous day).
Hedonomics uses the application of economics principles to study happiness. It’s not concerned with the philosophical questions, like “what is happiness” or “is it good to be happy”. Rather, it’s an assessment of how people make economics decisions to maximize their happiness.
Hedonomics has lead to a surprising finding about happiness that we can apply to retirement (early or otherwise):
Here’s the finding:
Person A is given $1 the first day, $2 the second, and so on until on day 10 they are given $10. In total Person A was given $55 over the 10 days.
Person B is given $6/day for all 10 days. In total Person B is given $60.
Who do you think was happier at the end of the 10 days? Would you guess Person B, since they were given $5 more than person A?
If so, you’re wrong.
Research has found that Person A will actually be happier than Person B, since Person A’s reward was increasing each day. Increasing rewards provide more happiness than a constant but higher reward.
And strangely, this matches the 6-year-old’s plan of eating a better chocolate every day – she was ensuring that her rewards were increasing over time.
Let’s dig into the implications of these findings.
Increasing rewards = happiness
This is something I touched on my recent post “Never touch the principle“. In that post I mention that one of the BIG problems with the 4% withdrawal rate is that you’re effectively locking in a standard of living for the rest of your life. No matter what you think, and no matter how much you enjoy your standard of living today, the reality is that in time you’ll grow accustomed to it.
If you can’t afford a cruise now…you’ll never be able to afford it. If you can’t afford a trip to Europe now…you’ll never be able to afford it. From an economic perspective each year is the same as the one before it and will be the same as the next year. There’s no growth and no progress.
Locking in a set amount of income, even if it’s indexed to inflation, is not the way to maximize happiness.
Occasional splurging = happiness
So what DOES provide happiness? Infrequent bursts of additional money (also known as splurging!) increase happiness. If you receive $3,000/month in retirement income but occasionally get an additional $3,000 to do whatever you want with (go on a cruise, buy new patio furniture so you can enjoy your backyard more often, etc.), this actually results in greater happiness than just receiving $3,500/month every month.
The key is that because the additional money is infrequent we don’t adapt to it. If we make our receipt of it random then it’s even better, as we won’t be expecting the money at all.
How can we apply these findings to retirement withdrawals?
First, we would be better off taking less money early in our retirement. This not only massively increases our chances of our money lasting as long as we do, but because it also allows us to increase our withdrawals later, leading to greater happiness. I advocate an initial 3% withdrawal rate – if you start there and gradually raise it (say, by .1%/year) then you’re guaranteeing a steadily growing income, even without factoring in the growth of your investments/dividends/interest over time.
Clearly, it’s important to have at least some money in investments that will provide growth. If you have a pension or other guaranteed income you need to find a way to generate a growing amount of additional income each year. Maybe this is done by saving 10% of your fixed income and investing the money into something that pays interest. As you save and invest the dollars will grow each year and you’ll be a bit better off than the previous year. The result? More happiness.
What do you think? Do these findings match your experiences in life? Have you found that you’ve adapted to the various financial situations you’ve found yourself in over the course of your life? Are you happier when you’re making financial progress? Is making progress the reason the ultra-rich continue to work long after they’ve amassed billions of dollars?