Why Advisors Should Distinguish Base and Discretionary Expenses in Retirement

Modern retirement theory assumes that all assets on an individual’s retirement sheet[1] (financial capital, social contract, human capital) should be used for their definitional highest and best purpose. To determine the highest and best purpose of retirement sheet assets, goals are prioritized and assets and liabilities are matched.

The difference in Base (mandatory or essential expenses) and Discretionary (voluntary or non- essential) expenses in retirement is fundamental and consequential. In practice, the distinction between Base and Discretionary expenses may be the most important decision a retiree must make to use assets efficiently and effectively in retirement income planning. Some advisors fail to highlight the difference between expense categories and claim that clients do not see food, shelter, insurance differently than country club dues or vacation cruises, hence the expense categories are combined and called ‘lifestyle expenses’. In our view, this is a distortion of affluence. ‘Lifestyle expense’ is an unfortunate term applied to these categories of expenses (Essential vs. Discretionary) and promotes the idyllic sense that to live the lifestyle one wishes these expenses should take on the same priority funding importance. Expense distinction is the most critical issue to maximize the best use of retirement assets to cover the Base (essential). The 3S model[2] posits net cash flow (Base Income) should cover Base expenses with sources of income that are simultaneously secure, stable and sustainable.

Advisors should always look for ways to add value to clients, especially if the advisor is operating under a fiduciary standard. An overlooked area for value-add in retirement planning is in the area of expense type or categorization. Many advisors in the planning industry question whether we should distinguish between types of expenses for planning purposes. The typical salvo is that clients don’t want to distinguish between food and country club dues, so why should we force them into expense categorization? If we fail to advise on this distinction, we miss a significant opportunity to properly frame client decision making. If the distinction has the potential to add value and improve outcomes, should not advisors, as a best practice, parse these expenses in planning? We make distinctions between different kinds of stocks (small, large, value, growth) or bonds (corporate, sovereign, or high yield), so why the push back on acknowledging expense types? The short answer is that if we push this conversation with a logical framework, we can increase client sustainability and add value.