Young Investors: Don't Stop Saving for Retirement

The life cycle model has shortcomings, but these do not indicate that you should stop saving for retirement early in your career. 

Ruth Saldanha 12 October, 2022 | 2:01AM
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Ruth Saldanha: Many readers and viewers recently were left wondering about a new piece of research that seemingly indicates that some young people should not be saving for retirement, especially early on in their careers. This is the opposite advice to what we at Morningstar have been telling you – we say you should save early, and save as often as you can – so that you can take advantage of the power of compounding. We still stand by that. Back to this new research – what it does do is point out that the ‘Life Cycle Model,’ which describes the spending and saving patterns of people over their lifetimes, does have it shortcomings. Morningstar’s Associate Director of Retirement Studies Spencer Look is here to tell us why. Spencer, thank you so much for being here today.

Spencer Look: Well, thanks for having me, Ruth. Happy to be here.

Saldanha: So the first thing I want to ask is should I stop saving?

Look: Good, first question, I'll keep my response to you brief. I don't think so. I think no, I think you should keep saving for retirement. Many factors to consider, but no, I don't think you should stop.

Saldanha: So let's talk about this life cycle model. How should young investors, mid-career investors, as well as soon to be retirees view it.

Look: Another good question. So the term life cycle model this refers really to any model that kind of goes back or ties back to the theory of life cycle spending and saving. Another kind of term for this is the life cycle hypothesis. What this theory provides, you know, it's a framework to guide investor decisions on spending, on saving. You know not only how much, but also how to invest it. There's really a lot that the theory provides. I think, one of the main takeaways from the theory is that investors prefer smooth spending patterns. Economists will call spending, consumption. So this is the concept of consumption smoothing. You know you want to have smooth pattern over time. And I think, overall it's a really powerful framework. We in industry use it as kind of the underlying engine for a lot of analysis. And I think investors, you know really early stage, but even to later stage in their career should view it this way too. It's a very helpful framework to guide with helpful insights, but I do think you should take the conclusions with a grain of salt sometimes there's assumptions, and there are shortfalls with the framework that don't always play out that well in the real world.

Saldanha: So what are some of these shortfalls?

Look: You know, I knew you were going to ask that. Shortfalls? You know, just like with any type of economic model or asset pricing model, really anything in finance, there's assumptions that don't play out that well or don't really make sense in the real world. I think, I guess the first one I'll talk through is the – an assumption that's made with the life cycle model that is used by the report or the paper that you referenced at the top, which I think is actually, very well written paper by the way, but an assumption they make is that. Future salary growth is certain, and so what that means is if you're 25, you know with certainty that your salary will be two times what it is now when you're when you're 40, for example. And in light of that, in light of that assumption, I think their finding kind of makes sense where if you know you'll have a lot more disposable income. Maybe it does make sense to spend everything now and then save later. The problem, though with this assumption of course, is that in the real world, your career arc, your salary growth is uncertain. And so, you know, that's one of the reasons we in the industry think it's prudent to save, when you can. Another shortfall I think I'll highlight which applies really to all life cycle models now, is the assumption that investors are rational, so another common assumption in financial literature, but definitely not one that is true in the real world. People have biases, you and me. We have biases that impacts our decision making. And I think I guess was applying this to the life cycle model finding from the report. If you are, you know, spending everything, you're not saving at all for retirements, you know, in your earlier years and then all of a sudden at 35, the transition point hits and then you're supposed to start saving 30% of your salary. That's a very hard transition or change to make, you know. There's the concept of inertia. You're used to spending everything and so that's just another way an assumption that people can just transition and behave rationally, may not play out that well in the real world.

Saldanha: So with that said, how should retirees or even young investors, mid stage investors, how should they view savings for retirement?

Look: Another good question, Ruth. I think regardless of, stage of investor, definitely early stage investors. You know I do think if you're in the habit of saving now, I think, I'd encourage you to keep saving. You know, stay the course and if you're not someone who's saving. I do recommend if financially you are able to do so, do save. There's just a lot of uncertainty, I talked about the salary growth and how that could change. But there's also so many other aspects of your lifestyle that could change with kids or other expenses, other things going on. And so in light of that, definitely recommend to save, when you can and take advantage of, you know, the power of compound interest to boost your wealth for your retirement.

Saldanha: Great. Thank you so much for being here today, Spencer.

Look: Thank you so much for having me.

Saldanha: For Morningstar, I'm Ruth Saldanha.

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Ruth Saldanha

Ruth Saldanha  is Editorial Manager at Follow her on Twitter @KarishmaRuth.


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