The academics are at it again.
In a paper provocatively titled “The Life-Cycle Model Implies that Most Young People Should Not Save for Retirement” no fewer than four of them take 48 pages to make that case. The “trade press” breathlessly intoned “Most Young People Should Not Save For Retirement in Their 401k,” “Many young people shouldn’t save for retirement, says research based on a Nobel Prize–winning theory,” “Under 35? Don’t Save For Retirement Yet, These Experts Say,” “Economists Say Enjoy Your Youth and Save Later.” At least one had the temerity to offer a contrasting viewpoint (see “A New Paper Says Young People Shouldn't Save for Retirement. Advisors Disagree”), while The Street at least called it out as “This May Be the Worst Financial Advice Ever Shared.”
Like most research, the conclusion is a premise based on assumptions.
Here the most basic is that this thing called a “life-cycle model” is
worth considering in the first place. Now, granted, it’s the “Nobel
Prize-winning theory” noted above—so mere mortals might be inclined to
give it some breathing room. But the underlying premise behind it is
that individuals prefer to smooth out their consumption over their
lifetimes, or—as the authors of the paper put it, assuming that
“rational individuals allocate resources over their lifetimes with the
aim of avoiding sharp changes in their standard of living.” Now, I don’t
know about you, but my aspirations—and I consider them rational—have
always been a bit higher than that.
Now, if you find yourself scratching you head at all that gobbledygook, it seems to boil down to this—you’ll get more “value” out of spending all of a smaller income now than you will suffer by depriving yourself—so that you can spend later when you’ll have more money to spend. Or something like that. But to put some numbers behind those assumptions, you have to do a little financial alchemy—create some sort of “value” for consumption—something beyond a mere price tag. How much DOES that cup of Starbucks that we’re always telling people to forego actually mean to them in terms of what academics call “utility”? Indeed, that’s another required assumption here—and it’s key in terms of assessing the perceived trade-offs.
What’s also odd here is that they actually talk about the “welfare costs” of automatic enrollment—essentially treating an individual who has been defaulted into saving as the equivalent of being scammed by a Nigerian prince.
And for those of you wondering what happened to the “magic” of compounding those savings, the authors have a direct, but quizzical response: “…there is no power of compound interest when real interest rates are zero. While individuals could invest in risky assets with higher expected returns (which we do not model), those higher returns are merely compensation for taking on the additional risk.” So, basically, in this magical theoretical world… it’s a “wash.”
Oh—and leakage? Well, in this world, since participation in plans by younger workers (who are particularly vulnerable to things like mandatory cash outs), they comment that, “Viewed from this perspective, leakages from 401(k) balances for young workers might be interpreted as correcting a mistake rather than a major problem in need of further government policy.” That’s right—early cash outs are a good thing (doubtless the taxes and penalties are considered a well-deserved “punishment” for the mistake of saving).
That said, the authors do offer some caveats—they admit that they’re focused on saving for retirement, and that there may, indeed be reasons for saving earlier for non-retirement purposes. But they also admit that their model “does not account for uncertainty about future wages, employment, or health.” They acknowledge that “if the wage profile is uncertain, or if there is a risk of future unemployment, individuals may wish to begin saving for retirement earlier in life in case future earnings do not turn out as expected.”
- Nevin E. Adams, JD