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A New Paper Says Young People Shouldn't Save for Retirement. Advisors Disagree.

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What You Need to Know

  • A new academic paper argues that most young people should not save for retirement.
  • The paper assumes people prioritize smooth lifestyle and consumption patterns over wealth maximization.
  • Advisors see the paper as food for thought, but they disagree with its conclusions and urge early savings.

As detailed on its website, the Journal of Portfolio Management Research strives to be the leading provider of independent financial research for all within the investment sector.

Launched in 1974, the organization seeks to bring forward some of the most prominent thought-leadership publications in the financial sector, including those that have, in the words of the organization, immeasurably changed the shape of the industry. Some of its biggest publications have included articles introducing or detailing the Sharpe ratio and the Black-Scholes model.

Now, a new paper published in the Journal seeks to question the common wisdom that it is almost always better for individuals to begin saving and investing for retirement as early as possible. This assumption, according to the paper’s authors, is so deeply baked into the mind of the typical financial professional that it seems almost beyond dispute.

However, according to the authors, the construction and analysis of a “lifetime savings consumption model” implies that most young people should not save for retirement. This conclusion is based on the assumption that rational individuals allocate resources over their lifetimes with the primary aim of avoiding sharp changes in their standard of living, rather than simply striving to maximize their total possible wealth.

The authors of the analysis include Jason Scott, managing director of J.S. Retirement Consulting; John Shoven, the Charles R. Schwab Professor of Economics at Stanford University; Sita Slavov, professor of public policy at George Mason University; and John Watson, a lecturer in management at the Stanford Graduate School of Business.

What the Model Says

The new analysis suggests retirement policy is often predicated on the belief that earlier saving is always better, thanks primarily to the power of compounding. This belief is used to justify the increasingly widespread practice of automatically enrolling workers in employer-sponsored defined contribution plans, the authors write.

But, according to the analysis, this assumption is often not evaluated against a meaningful benchmark. They suggest a reasonable benchmark would be a lifecycle model, in which rational individuals allocate resources over their lifetimes with the aim of avoiding sharp changes in their standard of living.

In running their analysis, the authors conclude that the lifecycle model implies that most young people should not, in fact, be saving for retirement.

According to the authors, most workers tend to experience substantial wage growth over their careers, and this is especially true for higher-income earners who will be more dependent on private savings to maintain their standard of living in retirement. For these workers, maintaining as steady a standard of living as possible therefore requires spending all income while young and only starting to save for retirement during middle age.

The analysis posits that low-income workers, whose wage profiles tend to be flatter, receive relatively higher Social Security replacement rates, making optimal early career savings rates very low. The paper further suggests low real interest rates make a front-loaded lifetime spending profile optimal.

Ultimately, the authors argue, the welfare costs of automatically enrolling younger workers in defined contribution plans can be substantial, even with employer matching. Among their concerns is that many young people end up taking on toxic levels of debt or making tax-inefficient withdrawals from savings to meet current spending needs, resulting in worse overall outcomes.

Reactions to a Contrarian Conclusion

Speaking with ThinkAdvisor about the paper’s conclusions, Amir Noor, director of financial planning at United Financial Planning Group, calls them “interesting and obviously not unfounded from a theoretical perspective.” But at the same time, Noor says, financial advisors can point to some obvious concerns about the findings.

“For starters, the paper seems to assume that, just because you have the capacity to become a high income earner in the future, it will actually come to pass,” Noor says. “I can tell you from the experience of serving clients that this is not always the case.”

Noor points to the example of a person who experiences a health care crisis that significantly derails their ability to work as anticipated. Or perhaps a person decides to prioritize the raising of a family or the maintenance of a low-stress lifestyle over earning the most money possible during their prime working years.

“I also find it hard to believe that lower income earners will just want to remain in that position forever, especially young people,” Noor says. “Many people who are low income earners earlier in their lives do not expect or hope to stay at that same income level throughout their lives.”

The authors of the study could not be reached for comment.

Paul Staib, principal of Staib Financial Planning, agrees with Noor’s take.

“Compounding of money has been referred to as the eighth wonder of the world,” Staib says. “The value of it is significant, especially for those who are younger and save earlier in life, as it increases the number of years over which the compounding occurs. Let time do the bulk of the work.”

Staib and Noor point out that saving at a young age also enables much more flexibility over time for altering personal spending patterns or pursuing an early retirement. These are things that most people value, they suggest.

“A savings mindset builds self-accountability and results in the saver being more self-sufficient and less dependent on other entities — company pension, Social Security, etc. — to fund their personal retirement,” Staib says. “Inherently, saving reduces certain risks associated with relying on outside entities for one’s retirement. There are also numerous behavioral benefits inherent in saving at young ages.”

Mike Hunsberger, founder of Next Mission Financial Planning, says he would agree with the findings if humans were purely rational actors. In reality they are not, and like Staib, he worries that the paper ignores some basic facts about behavioral finance.

“In theory this is great, but in reality, it’s not,” he says. “I am a huge fan of starting early with saving and making it a habit. This is one of my core beliefs. The main problem I see with not starting soon is, who is going to ring the bell and tell them it’s now time to start?”

Hunsberger notes that mid-career professionals in their 30s and 40s might have kids and higher costs for things like day care or sports activities. Expecting people in this position to pivot smoothly from a spending to a savings mindset is unrealistic, he says, even for those people who earn a significant amount of money year over year.

“Where are they going to find this extra money to start saving?” Hunsberger asks. “And, because they’ve waited, they now have less time for compounding to work, so they actually have to save more over the next 25 years to hit the same number. Again, it’s a rational argument, but I think it’s dangerous if it gains traction within the general public.”

Jason Blumstein, CEO and founder at Julius Wealth Advisors, points out that, if one studies how wealth is created in the United States, it flows more directly to company owners versus workers.

“So, if you want to try to build sustainable wealth, you need to become an owner, and an efficient way of doing this, especially for low-income workers, is via owning publicly traded companies,” Blumstein posits. “If you are a young worker but are not saving/investing early, you lose out on the power of compounding, which thus limits your optionality down the road.”

By not saving early, Blumstein suggests, an individual will likely lack the flexibility to take the calculated risk to self-fund the starting of a business.

“I like to tell people that the #1 answer in financial planning is, ‘it depends.’ Thus,” Blumstein says, “maybe this article is right, maybe it isn’t. It’s best to work with someone that truly understands what you want out of life.”

Daniel Yerger, president and chief operating officer of MY Wealth Planners, says the study is interesting, but he worries that it ignores the core fundamentals and the interplay between the life cycle hypothesis and the behavioral life cycle hypothesis theories.

Yerger notes that both theories posit that young people engage in “dissaving behavior,” i.e. taking on debt, early in their lives to do things such as attend college, buy homes and otherwise finance activities and assets that they cannot afford due to their low incomes (as compared to their future selves).

“In consideration of human capital theory (the dominant theory in explaining why people take on education loans and delay creating income), an argument that young people should not save for retirement misses the point,” he suggests. “Young people have low incomes and engage in dissaving behaviors because they believe that they can obtain skills and qualifications early in their lives that will magnify future earnings.”

Yerger points out that borrowing at low and moderate interest rates, as one often secures with student loans and mortgages, likely represents a lower lost opportunity cost than simply forgoing the long-term rates of return earned by the aggressive asset allocations viewed as appropriate for young people. Thus, young people absolutely should save for retirement, Yerger says, even if it requires more borrowing or use of credit in their earlier and lower income years.

Andy Gerhartz, a financial planner with Bridge the Gap Retirement Planners, says he will stick by the conviction that compounding is the most powerful phenomenon there is regarding money.

“Younger people have time on their side,” he says. “The more time one has, the more powerful the compounding can be. There are enormous opportunity costs of not investing early, and that opportunity cost is the lack of compounded growth on your money. If you have nothing saved and nothing to invest, you are not able to build wealth. Simple as that.”


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