How do you know when
It’s time to adjust spending?
Rising debts? Guardrails?

This week the Fed announced another .75% interest rate hike, with more likely to come. We can expect the Fed to continue to raise rates until inflation numbers cool down. Some analysts are now expecting the Fed to raise rates as high as 5%, up from about 3.5% earlier in the year.

AP News published a good article on Wednesday explaining how rising interest rates ripple through the economy into every American household. The consumers who get hit hardest in this kind of interest rate environment are the ones in need of a big purchase. Big purchases are often made with the help of debt, and loans are as expensive now as they have been in years.

This highlights a growing concern in the American economy. Per the AP article, “Americans are increasingly relying on credit cards to help maintain their spending.”

The obvious cause of this is that everything is more expensive, including necessities like groceries and gas. According to the Bureau of Labor Statistics, as of August 2022, gasoline was 25.6% more expensive than it had been the year before. Groceries were more expensive by 13.5%.

This means that someone who spent $2,500 on gas in 2021 might be spending $3,140 this year.

Someone who spent $15,000 on groceries in 2021 might be spending $17,025 this year.

But some financial experts point to a different cause for the increasing debt load. Michael Burry was profiled in The Big Short as a hedge fund manager who correctly predicted, and ultimately profited enormously from, the Great Recession of 2007-2009.

His thinking goes that when the government created economic stimulus in response to the pandemic, people suddenly had more money to spend. The concern at that time was that this loose fiscal policy would increase inflation, which may be what happened.

What wasn’t discussed at that time was that people would grow accustomed to having some extra spending money and would therefore grow accustomed – or as Burry says, addicted – to a higher spending rate. People got used to spending more money, and when everything grew more expensive, they turned to credit cards to maintain their purchasing rate.

But high interest rates mean that more money will have to go to paying off debt. Even people only making minimum required payments will see those payments increase. This means they’ll have less money to spend, and the environment will force an adaptation to a lower spending rate.

Changes in sunlight and weather signal migratory animals that it’s time to get a move on. A rising outstanding credit card balance tells a person that it’s time to pay attention to household finances.

The problem isn’t having to adapt. The problem is wasting time and energy being upset about having to make changes. Nothing lasts forever, neither the good times nor the challenging times. Being too attached to a temporary environmental condition may leave a person unprepared when changes inevitably happen.

Today, we have the most sophisticated tools yet devised to calculate safe spending rates that can endure changes in the financial ecosystem. Something as commonplace as Google Sheets is comically more advanced than the most sophisticated instruments from forty years ago.

Calculating safe spending is relatively easy for someone in their working years.

“Spend less than you make” is sage advice for people in their working years. Someone earning income from employment knows what they make each year. That number is a constant in the make/spend/save/give calculus. Knowing income means knowing how much you’ll owe in taxes, and how much will be left over to save, spend, and donate.

But retirees don’t have that constant anymore. Instead, expenses dictate how much money they need to draw from savings and investments. “What you make” becomes dependent on variables like dividend income, interest rates, and market appreciation.

Monte Carlo Analysis has emerged as an industry-standard method for navigating the shifting seas of passive portfolio income. This analysis involves software taking a person’s financial data – the household assets, liabilities, income, and expenses – and running hundreds of simulations where that household’s money is exposed to a wide variety of market conditions.

The result of Monte Carlo analysis in financial planning software is a Speedometer-looking graphic which shows a certain percent chance of “success.” Success in this case is defined as “not running out of money.”

For many people, Monte Carlo analysis that incorporates high inflation and end-of-life expenses like 24/7 nursing home care will show a result that is less than a 100% chance of success. This means that a certain percent of simulations showed that the household in question ran out of money.

What Monte Carlo analysis doesn’t show, however, is the capacity for adaptation.

In fact, a less-than-100% chance of success does not mean that in some scenarios a household may be financially destitute. What it means is that in a certain percent of economic conditions, a household may need to spend less money for a certain period of time.

For many people this is good news. A 10% “chance of failure” sounds terrible. But a 10% chance that you may have to take a pay cut of between 1-3% doesn’t sound so bad. The underlying methodology behind this approach to retirement spending is called Guardrails.

People relying on portfolio income can set an upper guardrail – a point where the total value of their assets indicates that they can spend more – and a lower guardrail – the dollar value of their portfolio at which they should reduce portfolio withdrawals. Connecting income to net worth in this way means a retired household won’t have to wait for the signal of increasing credit card debt before knowing that spending should adjust downwards.

People are having to adapt to a new and challenging environment involving supply line disruptions, escalating turmoil overseas, and the uncertainty of midterm elections.

Firms like ours exist to help people navigate changes. This means helping people avoid potentially harmful decisions during difficult times. It also means maximizing the benefit and enjoyment a person can get from good decisions.

If you need help navigating the rapidly shifting landscape we’re all dealing with these days, that’s what we’re here for.