Put Off Saving for Retirement

by Philip Brewer on 13 December 2011 18 comments
Photo: Philip Brewer

Here's an unpopular idea. Everybody knows that you should start saving for retirement as early as possible, because everybody's seen the calculation where you put aside a few dollars every month starting at age 20 and with compound interest have a huge amount by the time you're 65. (See also: Don't Despair Over Small Retirement Savings)

There are three big problems with this scenario.

The first is that, right now anyway, it's impossible to earn any interest. That's not generally true, but it is true that you can't assume that any particular rate of return is going to be possible. (If only I were as rich as I'd imagined I might be when I did these sorts of calculations in the early 1980s, when long-term government bonds were paying 14%!)

The second is that there are certain phases of your life when you really need the money, and one of them is when you're first starting out. When you're trying to set up housekeeping for the first time — buying pots and dishes and furniture (not to mention paying off your student loans) — a few hundred dollars is going to make a much bigger difference to your standard of living than it will make when you're retired (even with compound interest).

The third is that people's incomes are low when they're young. Even with compounding, the ultimate contribution of those small, early deposits is insignificant, compared to the amount of money you can sock away in the last few years of your career.

The real reason to start saving for retirement early is to establish the habit of saving. So, let me be clear — I'm not recommended that you put off saving. I'm just recommending that you put off saving for retirement. By all means, start saving early. Save for an emergency fund. Save for down payments on a house and a car. Save for a vacation. Save for a luxury item you really, really want. Develop that habit of saving. Then, in a few years, when your income is a little higher and your household a bit better established, go ahead and start saving for retirement.

Your retirement will be just as secure, and your first few years will be a lot more comfortable.

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Guest's picture
Beth

I can see your point, but I respectfully disagree. It's all too easy for "later" to become a moving target. My first job had a pension plan, so I was used to saving x % for retirement right off the bat and it was easier for me to continue that habit even though I switched jobs. And yes, that meant I lived without vacations and I slowly acquired things for my home (a lot of it used) rather than getting it all right away. I have an older TV and an even older car.

For me, it wasn't just about developing the habit of saving but developing the habit of thinking long term (that is, beyond a vacation or a piece of furniture). It's about setting priorities -- if I can't afford to donate and save for retirement, then I can't afford a big trip or a couch just yet.

I realize my approach won't work for everyone and people should do what's right for them, but I think it's easier to set those long term goals right at the beginning than it is to all of the sudden decide you need to start saving for retirement and trying to figure out how to work that into your budget later.

Guest's picture
Guest

I'm not sure I agree with you here, though it's certainly good to think about saving for retirement critically. By funding a Roth IRA, you are able to purchase more shares when the market is down (such as now), and that will grow exponentially over time (provided you have faith in the market, which I do). By saving early, even if only $50 per month, the savings can be well worth it later in life. Also, a Roth IRA can serve as a long-term savings account, as the contributions can be withdrawn penalty free at any age.

Guest's picture
Guest

The only people that are going to agree with this article are the people looking to justify their excess spending. This is poor advice.

Andrea Karim's picture

I sincerely doubt Philip is encouraging excess spending. He does have a point about not earning interest - why not invest in something with higher returns than a 401K will currently give you?

Guest's picture
ermine

I agree with it, indeed I take exactly the same issue with the save for retirement as soon as you get a job mantra. It goes along with my experience of early working life, and I managed to catch up.

Guest's picture
Jim

Saving early means having to save less later when you will have the income for the things you want. I would rather save 10% now than 22% later. Additionally, if your employer is matching your contribution then you are giving up free money if you don`t put in the minimum.

Philip Brewer's picture

Ah, but that's exactly my point!

When you're first starting out, saving 10% is really tough. Your finances are stretched, your household possessions are meager. When I was first starting out, the minimum 401(k) contribution to get the full employer match was 6%, and I found it tough to contribute that much.

On the other hand, later in your career, when your income is higher and your household is established, contributing 22% is easy. The last few years I worked a regular job, I was contributing 17% to my 401(k) (the maximum my former employer allowed), plus I was putting about the same amount into ordinary savings and investments.

It was exactly that experience that prompted this post. Just 6% of my starting salary was really hard, while 34% of my late-career salary was trivially easy. (And it was 34% of a lot more money.)

That's exactly why I suggest that you put off saving for retirement. (Just don't delay developing a habit of saving.)

Oh, and do get your employer match, if you work for an employer who still does that sort of thing. But not because it's for retirement—because it's free money.

Guest's picture
Beth

@Philip -- I think where you're losing people is that you recommend saving for things like a vacation or luxury item. Give how many "boomerang kids" there are these days, I can see your argument for delaying retirement savings and working on establishing a household. (Like saving up for rent or furniture before you move out of your parents or student residence.) My priority would be paying down debt and building an emergency fund, not saving for a vacation.

Guest's picture
Guest

“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”
― Albert Einstein
Even better is a DRIP - Dividend Re Investment Program. Many companies will reinvest your dividend with no charge, and some even offer a discounted price. Given that these companies also frequently raise their dividends over the years, this is a slam dunk. One example is AT&T, currently paying about 6% (do your own due diligence). My $2000 original investment is now providing $6000/year to my happy retirement.

Guest's picture
Guest

I tend to agree with your opposition's views. The idea with early savings is to get into the savings habit, BEFORE your budget is fully appropriated to bills and loans. As I learned early, "pay yourself before others". You earned it, you deserve it.

Thanks for listening, Bill

Guest's picture
Guest

I saw a great point on Gail Vaz Oxlade's blog this morning: that putting money aside for a vacation or a purchase isn't "saving" -- it's planned spending.

Food for thought.

Philip Brewer's picture

In that sense, so is your 401(k)—spending planned for after you retire.

In fact (although I doubt if your blogger was thinking of this), that's a great way to think about it. All your saving is really planned spending, even money that you plan to leave to your heirs. (Spending planned for after you die.)

That's not to say that saving isn't a great idea. It makes your household more secure, because if things don't go according to plan, you've got cash. It raises your standard of living, because your savings can earn a return.

But the biggest win probably comes from having a plan.

Guest's picture
Guest

@Philip I had the same thought about an emergency fund! I was thinking "this is money I don't know I'll have to spend yet." For instance, you don't know if an emergency fund will be needed for health, a job loss, etc, but it's there to keep you from getting into debt.

And I'm guessing you haven't heard of Gail. :) Her blogs, books and TV shows are worth a look even if you aren't Canadian.

Guest's picture
Ed

Saving early means that these first dollars have 40,50,60 years to compound. Don't gamble that you'll be able make up for this later. Be smart.

Guest's picture
AndrewH

While I certainly understand that saving early is "harder" in that even small percentages have a larger lifestyle impact, resepectfully, you are taking the anecdotal evidence of your personal situation and assuming this will work out for everyone. As a CFP, I have been working with clients for many years (as well as being director of a university CFP Board registered financial planning program) and it is precisely BECAUSE people have waited to really start saving that they are woefully unprepared for retirement. At first it is pots and pans and iPhones and student loans, then it is weddings and children, then it is upgrades to the house, then it is college for the kids and then, boom, retirement! All along this was likely coupled with yo-yo management of consumer debt. Finally, things may settle down and they can up their savings rate but by that point they will have very likely torpedoed the most important portion of the future value equation: FV=PV(1+i)^n. N being the number of compounding periods...the only exponential part of that equation! I know you are not saying to forego saving altogether, but it is phenomenal what even nominal amounts deposited today will be worth with more "n's." And the higher those deposits, the more powerful those "n's" become.

Additionally, your first stated reason to delay serious saving is highly problematic. Your statement that current interest rates being near or at zero completely ignores that proper saving early on involves dollar-cost-averaging into an equities-heavy portfolio and even if RIGHT NOW rates aren't terribly attractive, history paints vivid pictures of times like now being absolutely IDEAL to be planting as many retirement seeds as possible!

I hate to be the guy pulling credentials near the beginning of the post but this is a VERY sensitive area for me. Any advice giving anyone he impression that it is okay for them to be "actively neglectful" of their retirement saving early on puts my back up and I feel the need to come out guns blazing.

Guest's picture
AndrewH

While I certainly understand that saving early is "harder" in that even small percentages have a larger lifestyle impact, resepectfully, you are taking the anecdotal evidence of your personal situation and assuming this will work out for everyone. As a CFP, I have been working with clients for many years (as well as being director of a university CFP Board registered financial planning program) and it is precisely BECAUSE people have waited to really start saving that they are woefully unprepared for retirement. At first it is pots and pans and iPhones and student loans, then it is weddings and children, then it is upgrades to the house, then it is college for the kids and then, boom, retirement! All along this was likely coupled with yo-yo management of consumer debt. Finally, things may settle down and they can up their savings rate but by that point they will have very likely torpedoed the most important portion of the future value equation: FV=PV(1+i)^n. N being the number of compounding periods...the only exponential part of that equation! I know you are not saying to forego saving altogether, but it is phenomenal what even nominal amounts deposited today will be worth with more "n's." And the higher those deposits, the more powerful those "n's" become.

Additionally, your first stated reason to delay serious saving is highly problematic. Your statement that current interest rates being near or at zero completely ignores that proper saving early on involves dollar-cost-averaging into an equities-heavy portfolio and even if RIGHT NOW rates aren't terribly attractive, history paints vivid pictures of times like now being absolutely IDEAL to be planting as many retirement seeds as possible!

I hate to be the guy pulling credentials near the beginning of the post but this is a VERY sensitive area for me. Any advice giving anyone the impression that it is okay for them to be "actively neglectful" of their retirement saving early on puts my back up and I feel the need to come out guns blazing.

Guest's picture
Guest

Dear Philip,

First, I'm a big fan of your blog. So I write this from a position of huge respect for your opinions.

But I'm not sure that saving for retirement is usually harder when you're starting out. Of course, it *can* be, if you're not working full time or have huge student loan debts. But my experience was that the time before marriage, and especially before children, was the very best time to save.

As a single person without kids, you have the freedom to live in a cheap apartment, maybe one that would be unsuitable for a family. If you're young *and* healthy, you can accept all sorts of inconveniences such as walking or biking long distances to work. Without childcare expenses, you have the maximum freedom to work long hours or overtime. It's the perfect time to save a large portion of your income, even if that income is small.

In my first year at a "real" job, I made about $28K, and I saved about half of that, some in a retirement account, most in a regular savings account. When I got married, we had about $20K in savings. That $20K made all the difference in our future finances. It provided a cushion for emergencies, capital for improvements, etc. It is the most important $20K I ever saved, and it turned the tide from spending interest to earning interest and therefore enabled us to "get ahead".

And the small amount I was able to contribute to my retirement account during those early years is now (15 years later) worth about $7K -- about twice what I contributed. Not a huge percentage of my total savings, but not negligible either. But more important than that $7K was all of the good habits established: opening an account with TIAA-CREF, learning about payroll deduction, etc, and generally learning to think long-term. Those are priceless lessons for a person in their early 20's to be learning.

Thanks again for your very interesting blog.

Philip Brewer's picture

Yes, it's the habit of saving that's key.

If your circumstances are such that saving is easy (for example, if you're living at home for a few months after finishing college and before you need to start making student loan payments), you'd be crazy not to save a huge percentage of your income.

It's just the fixation on "retirement" savings that seems wrong to me. There are so many other things to save for: security deposit on an apartment, an emergency fund, down payment on a car, and so on.

In fact, I'm kind of doubtful of the whole idea of "compartmentalizing" your savings. Yes, there are certain kinds of accounts (called "retirement" accounts) that have some tax advantages if you leave the money in there until you're 60 or so. But really, your whole pool of savings and investments (including the money in those accounts) should work together to support all your goals.

I wrote about that a while back:

http://www.wisebread.com/the-one-big-lump-theory-of-your-money

That post is mostly about how naming the accounts after your goals leads to making poor investment decisions, but it also leads to making poor saving and spending decisions as well.

Thanks for the kind words!