Savings grace

Behavioral New World

May 1, 2024

Savings grace

Many of you have heard the age-old advice to save at least 10% of your income. The idea is to automate your savings, removing the temptation to spend that money. Often accompanying that advice is: Start early. By starting early, you benefit from the miracle of compound interest—regular savings grow exponentially, not linearly.

There is a substantial portion of the U.S. population that would benefit from following this advice. Example: in 2022, the median retirement savings per family was about $87,000 (link). To put this number in perspective, this is almost exactly what a family of three spends in a year (link).

Alarmingly, households between the ages of 65 and 74 have only a median retirement savings of $200,000 (link), suggesting that households don’t use their working history to amass sufficient retirement savings. Yet a recent survey shows that Americans think they will need $1.46 million to retire. (link) Hmm….

But there is a portion of the population that has the opposite problem: They have saved for too long and saved too much, but—because of age or health setbacks or simply bad luck—they cannot enjoy their wealth. The trouble with delayed gratification is that you might not get to the gratification. I know people who have this (admittedly first-world) problem.

Couldn’t happen to you? “According to the World Health Organization, the average American can expect just one healthy birthday after the age of sixty-five.” [link] And even if you are in good health at 66, you might not want to backpack around Europe for a couple of months. Or climb Mt. Kilimanjaro. Or play rugby.

Economists call this a “consumption smoothing” problem. Over your lifetime, there is a balance between spending and saving for later. That’s tricky, of course, and there is no formula, but my advice is to avoid mindless saving. By thinking about the consumption/saving tradeoff, you can avoid a scenario in which you deprive yourself for years and then cannot enjoy the fruits of that deprivation.[1]

There’s an interesting group with a third savings pattern. FIRE stands for Financial Independence, Retire Early. FIRE adherents engage in extreme saving, sometimes up to 70% (!) of their income. Their goal, as the name suggests, is to retire early, say, in their 30s or 40s. For those who do not have an extremely high income, a savings rate of 70% means a lot of deprivation.

Although my default is “live and let live,” I have reservations about FIRE. First, imagine that you retire at 40. You can reasonably expect to live another 40 or 45 years, and you need to finance that from your savings. One website [link] says that FIRE followers typically withdraw 3 – 4% of their savings every year. If you’ve saved $1 million (your results may vary), that’s $40,000 per year, hardly allowing for a lavish lifestyle.

Second, many retirees find that retirement is not the golden, laid-back, enjoyable experience they envisioned. Many miss their social connections at work. It turns out that lying in a hammock eating bonbons gets boring; who knew? Suggestion: Retire to something, not from something.

In sum, if you are an under-saver, you probably know it, consciously or not. Of course, if you have a meager income, saving may not be possible. But for many, there are techniques for increasing your savings rate—see Chapter 7 of my book, The Foolish Corner, available on Amazon.

The cautionary tale I’m emphasizing here is about saving too much, depriving yourself of memorable experiences, only to wind up with more money than you can spend. I offer no specific advice beyond, “Don’t deprive yourself too much.” “Too much” is, of course, subjective, but you are going to make better decisions if you think carefully about the consumption/saving pattern over your lifetime.

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[1] An excellent book on this topic is Die with Zero by Bill Perkins.