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  • Marius

Worried that you didn't start saving early enough? The latest research surprises financial planners.

Updated: Dec 26, 2022



We've all been indoctrinated with the idea that it's necessary to start setting aside money for retirement as early as possible. Many institutions and advisors would have you start saving aggressively from your very first paycheck. For instance, Fidelity suggests that a 25-year-old should be saving 15% of their income for retirement. They continue by recommending that a 30-year-old should have already saved 1x their annual salary, 3x by age 40, 6x by 50, 8x by 60, and 10x by 67.


If you feel inadequate when comparing your own savings to the goals above, you're not alone. Whether due to financial setbacks, keeping up with the cost of living, or having different priorities, many people early in their careers find it difficult or impractical to save for retirement.


Conventional reasoning as to why young people don't save is counterproductive. Blaming a lack of discipline (avocado toast) or external factors (student loans and rent) leads to feelings of being overwhelmed, which results in avoidance... which fuels further cycles of stress and avoidance. No wonder personal finance is such an awkward topic.


Most people save to maintain standard of living in retirement

Between 1952 and 1954, Richard Brumberg and Franco Modigliani wrote a couple of essays that introduced new theories as to why people save. These theories eventually became known as the Lifecycle Hypothesis and earned Modigliani a Nobel Prize.


One interpretation of the Lifecycle Hypothesis is that people save primarily to maintain their standard of living in retirement. A more accurate description is that people value consistency in their ability to spend and enjoy. This is called consumption smoothing. For instance, if income is high one year, but expected to be low the next, it is better to set some of that extra income aside to maintain a consistent level of expenditure rather than live like a prince one year and a pauper the next.



Saving for retirement improves the standard of living in later years at the expense of the present, all with the hope of maintaining consistency throughout. But it is possible to save too much - yes, really!


Most young people should NOT save for retirement

In the most recent Journal of Retirement, economists applied the Lifecycle Hypothesis to young people. They concluded that not only is it possible to save too much, but it is also possible to save too soon. The Lifecycle Hypothesis implies that most young people should not save for retirement!


Smoothing consumption is not just about enjoying retirement; it's about not wasting your youth.


Most people experience an increasing income over the years. Someone with a rising income has a unique challenge in the early years of their career. Their average lifetime consumption would be higher than their present income allows. Any amount of saving at this time, even saving the minimum required for the employer's 401k match, would be saving too much. Saving at this stage would make consumption less smooth.


Not only would most young people not want to save, but the if difference in earning power from early to late career is large enough, smoothing consumption may be impossible without getting into debt!


Are lower income workers, who tend to have flatter wage profiles, screwed? Not according to the theory. Social Security replaces a much larger portion of their income, dramatically reducing the optimal savings rate.


Maybe 401k automatic enrollment is not such a great thing after all.


This is not permission to be reckless

So far, this should be good news for most people. Have fun, enjoy life, maybe take out some loans, and don't worry if you aren't meeting some preconceived standard for savings success.


And yet, you still need to save for an emergency fund to ride out the bad times. Remember consumption smoothing.


Also remember that debt, especially high-interest loans, can be hazardous to your wealth if improperly managed. Don't take out loans that you can't afford just because some economists say that borrowing might be optimal.


Finally, these are broad guidelines based on an imperfect model, not financial advice.


Is this the right time to start saving for you? How much? That depends on many factors: how many years you have until retirement, your desired lifestyle, and the profile of your assets, debts, and income. It's OK to ask for help. That's where we step in.


We help you find answers to those questions as part of our collaborative financial planning process. Financial planning is not only about finding enough for retirement, but also about making the most of today.



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