Bryan Keller has just written a very astute email taking issue with my retirement advice for twentysomethings, and asks if it doesn’t contradict slightly the points I made when I was promoting financial wellness. Keller says that financial wellness is more than just staying out of debt: it also involves saving a reasonable amount. He continues:
The whole act of saving money is one they relies heavily on actions that run contrary to people’s emotional and psychological makeup. And to effectively encourage someone NOT to begin establishing precisely the habits and behaviors that creates, and ultimately leads to, financial wellness, confuses me.
I think the bottom line is really this: the act of saving is habitual and needs to be nurtured from a young age. The expectation that we can encourage people not to save in their twenties, and then expect them to just flip a switch once they hit they’re (insert proper age here), is naive. Our society needs to be weened off of our unsustainable consumption habits, and to a more balanced approach that nets out to savings accumulation. Our culture’s current financial awareness is not such that we can discourage any form of saving, even at a young age.
It’s a good point, although saving doesn’t run counter to everybody’s psychological makeup. Many people will, yes, go out and spend every penny they’ve got; many more will further spend every extra penny they can borrow. But there are two other substantial groups too. One is those people who like to have a cushion of savings to fall back on (or to use, eventually, as a down-payment for a house); the other is people attracted by the concept of financial markets as a place to grow your money, and the idea that you can make money not only by working for it but also by investing it wisely.
I’m actually quite unsympathetic when it comes to this last group, despite the fact that they’re almost certainly disproportionately over-represented among my readers. For me, the best way to earn money is to earn money. Financial instruments can be a sensible place to put the money you’ve earned and haven’t spent — your savings. If you’re wise, your savings will then grow. But by far the best way to maximize your savings is to save more, not to try to invest them in a clever manner.
So how to reconcile the advice to spend your money when you’re young and it’s most valuable to you, with the advice to save?
Firstly, take a look around you at work. Do nearly all of your colleagues make substantially more than you do? And do you intend to continue working in more or less the same career/industry for a few years at least? If you can answer yes to both questions, then it’s entirely fine to save only insofar as it’s stupid not to (when you have employer-matched pension contributions, for instance).
On the other hand, if you’re making a lot of money in your twenties and you don’t think that’s sustainable — perhaps you’re working as a Wall Street trader, or a highly-paid athlete — then of course you should be saving a very large amount of your income.
But let’s stick to the situation that most twentysomethings find themselves in: starting out on the bottom rungs of the career ladder, with money very tight. Do I think it’s sensible to encourage such people to save for retirement just because saving is a Good Habit? No. But I do think that most such individuals have a mental idea of the point at which money would not be tight: the point at which they really should be able to start saving.
So here’s one piece of advice: write that number down. Chances are, you’ll reach it, and when you do, you’ll discover that money’s as tight as ever. It’s called the hedonic treadmill, and it doesn’t do you any good at all. So promise yourself now that a substantial part of any income over and above that number will be saved. Not necessarily for retirement: a simple savings account at your local credit union is fine, especially if you need to save up a down payment on a house. Once you do start earning more money than you need, you’ll have made a promise to yourself to save it rather than spend it.
It’s worth noting here that there’s a world of difference between savings, on the one hand, and retirement savings, on the other. My blog entry yesterday concentrated on retirement savings: long-term stock market investments which are tied up for decades. Those are less useful, and therefore less important to a twentysomething, than common-or-garden savings-account savings which can be used to buy property or in some kind of emergency.
Once you’ve amassed at least a few thousand dollars in real-world savings-account savings, then you can start worrying about stock-market investments and asset allocation and retirement. But in the mean time, if you’re struggling to choose between a pension contribution and a trip to Nepal, take the trip to Nepal.