Can you save too much for retirement?

by Pop on April 6, 2011

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And can I contradict myself in a week?

When I was in college, I dressed like a homeless person. Now, I dress like I’m in college. It’s not that I can’t afford nicer clothes. Thankfully I’m well beyond the “no money” years. It’s just that I never really “upgraded” to the stuff most of my peers are wearing nowadays.

So I should be patting myself on the back, right? Living like a poor person—when you’re not—is one of those tried and true personal finance adages that mark classics like The Millionaire Next Door. The millionaires live like they’re not rich. They buy used cars. They eat at home. Then they retire early or spend retirement travelling the world because they’ve saved so much gosh darn money.

But sometimes left out of the discussion of saving, is how much is too much when you’re retirement planning.

To take it to an extreme and keep things simple, let’s say we’ve got a 25-year old making $60,000. He’s totally bought into saving like a madman and maxes out a Roth IRA and a 401k every year until he retires. Based on one, mainstream retirement calculator, that would give him about $8,900 per year per month once he retired at age 66—almost two and a half times what he used to live on at age 65.

He could fund two of his retirements, and still have half a retirement left over. Should we celebrate that?

The concept of “consumption smoothing”

I think most people would say “No.” The 25-year-old self was cheated out of current pleasures…his trip to Norway, his “grown-up” clothes…that would have been perfectly fine for him to buy. Instead, his 80-year-old self either goes on a spending binge, leaves a large inheritance, or tries to pay off St. Peter.

Instead, many economists consider the ideal savings amount to be that which “smooths” your consumption over your lifetime. In short, you want your quality of life in your 60s and beyond to be about as high as it was in your 30s.

At some point and to make things simple, personal finance gurus started to back out savings targets—like 10% or 20%—that would achieve consumption smoothing as long as the stock market hit certain rates of return.

Laurence Kotlikoff, a Boston University economist, a few years ago took it so far as to create an extremely comprehensive retirement calculator, that can show you how much you should consume every year into and through retirement based on the assumptions you put in. (Here’s the more basic, free version.)

Can you save too much for retirement? Yes! But in personal finance circles, it’s generally not “cool” to spend. A recent Wall Street Journal column derided people who buy iPad 2s (or is it iPads 2?). The logic: It’s really costing you $2,000 since you could have invested it instead! By that logic, I should really feel bad about my $5 lunch today—that could have been $20, after inflation, in 2041. This year, I will blow $7,200 of my future money on lunch. I’m such a moron.

The columnist’s logic assigns little to no value to present enjoyment, in favor of future enjoyment. That makes no sense.

Don’t get me wrong, this doesn’t apply to most people. Most Americans will retire with little to no savings. And those people shouldn’t be buying iPads. But given that you’re reading this blog, I’m betting you’re putting at least a bit away already, or at least thinking about putting a bit away.

Throw uncertainty into the mix, and suddenly saving “too much” seems impossible.

The idea of consumption smoothing has a major flaw, of course: uncertainty. We don’t know what stocks will return over the next decades. We don’t know where tax rates will be or if we’ll be in a car accident or if the roof will need to be replaced, etc.

Or perhaps a more dire situation: Imagine you’re a 53-year old staring down the newly proposed Republican budget. In 12 years, you were expecting Medicare. Bzzzzz. Wrong. Maybe you could have seen some sort of Medicare reform coming, but you probably didn’t predict the fairly random age-55 cutoff that would probably allow you to save thousands in insurance costs if you had only been born in 1956.

There are two ways to react to that uncertainty: To save as much as you can in case a worst-case scenario comes along or to save for a best-guess scenario and risk having to cut consumption if the dice come up snake eyes.

I’m saving for a “best guess”, with the reasonable safety measures of a year-long emergency fund, an annuity, etc. Sure, fate could frown on me, but I’m not willing to make a guaranteed sacrifice of reasonable happinesses today just to prepare for a possibly scary future. There’s a chance, my 66-year old self might be unhappy with the current me, but he’s going to have to deal with it.

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{ 19 comments… read them below or add one }

Dangerman April 6, 2011 at 1:25 pm

“$8,900 per year”

typo? “per month”?

Janette April 6, 2011 at 1:48 pm

Yup, I was born in 1957! OW!
I thought we had saved enough for retirement. As of yesterday- I am seriously considering returning to work.
I am a bit ticked that my brother, who has saved nothing, will receive Medicare fully- but I will not. So much for believing in the fairy tale!

Daniel Reeves April 6, 2011 at 5:01 pm

You beat me to the punch! I was just working on a similar argument: http://messymatters.com/savings?secretpreview

The “you could’ve invested that” idiocy is very annoying. People need to grok the concept of future discounting.

krantcents April 6, 2011 at 7:39 pm

I would rather save too much than not enough! I am enjoying my life too. We travel overseas every other year and a minor vacation every year. One of our minor vacations was a week in Vancouver, BC and 5 days in New Orleans, LA.

Pop April 6, 2011 at 10:41 pm

@Dangerman – Good catch, thanks!

@Janette – You can take solace in the fact that it’s nearly impossible to get anything huge done in Congress, especially with one this divided. By the time they pass something, even if that part stays in there, maybe you’ll have made it to 55!

@Daniel Reeves – Awesome to see someone using “grok” in a post and a comment. I wish there was a way to feel discounted future rewards in the same way we feel present rewards. Do you know if anybody’s studied extreme savers? I wonder what parts of their brains are firing when they think about a rich retirement versus a present-day iPad.

@krantcents – Agreed. I wasn’t meaning to bash savers! Balance is key.

Daniel Reeves April 7, 2011 at 1:52 am

@Pop: Some theories:

1. Their sense of self-worth is tied up with their bank balance.

2. They’re altruists with high value for leaving money for their heirs.

3. They’ve grokked the mathematics of compound interest but not the corresponding (roughly identical) mathematics of future discounting. So they really believe it’s crazy to spend $5 now that will eventually become hundreds of dollars if they invest it.

4. Plain old OCD? (Like maybe hyperfocus on their goal of retiring.)

Tim April 7, 2011 at 10:51 am

@Daniel Reeves – I think that these were good comments. Especially the one about leaving money to heirs. Some people (and I don’t have any children) find that making the next generation better off than they are is a very noble goal.

@Pop – I’m glad you brought the uncertainty line in at the end. If it weren’t for uncertainty, we’d all know exactly how much we’d need to save for retirement to retire in 20XX. It’s one of the main drivers for me to “oversave” at this point in my life (I’m 32).

One final thing is that certain people (me) might find that their utility gained by saving $20 today is greater than the best possible purchase they could make. Do I want a picture frame? Sure. Can I maximize my utility somewhere else? For me, yeah, bank it.

I assume that my preferences will change as I age, but that’s my reason for saving right now. It makes me feel good. Even though it’s at a rate higher than I really need to. I can always choose to save less in the future, but I can never choose to save more in the past.

Jason April 10, 2011 at 7:39 pm

It depends on how much you want to be living it up during retirement.

Edwin @ Cash The Checks April 24, 2011 at 3:52 am

I’d rather save more than enough than not save enough.

T K April 28, 2011 at 12:43 pm

Seems that everyone is forgeting that saving now is based on earnings now.

Jules April 28, 2011 at 12:54 pm

My hubby and I are saving decently right now. 15% of our income, not counting an additional 4% each in 401k. now, we’re mostly able to do that and not sacrifice our lifestyle (we like to travel a couple times a year and go out to nice restaurants, etc.), by having bought a smaller, cheaper house than we could’ve afforded. I think the age of the mcmansion is over. we also did most of the remodeling ourselves and saved on remodel costs. I also am still driving a base-model car i bought 9 years ago, and paid off 4.5 years ago. If people really look at the things that eat up their disposable income (often large houses and new expensive cars), they will find ways to cut back in some areas, save more and still be ale to have fun. also, we’re saving a good amount b/c we don’t have kids yet but would like to sometime soon. When we do, i will be qitting my full-time job, so we’re anticipating our income to be considerably lower, at which point we may need some of those savings to actually pay bills. everyone is saving for a reason and yes, you have to have a good balance between saving too much and not enjoying your present day, or not saving enough to get by when you are old and frail.

Stephen Robbins May 19, 2011 at 1:52 pm

@Pop and @Daniel Reeves: I think that Daniel in part has the idea, but I propose that reward has little to do with super savers compared to the negative pain of spending money.

Perhaps it is the case that they are simply so far down the cost-conscious spectrum that any expenditure feels like they are getting a bad deal, but they suck it up for the necessary expenses (e.g. food). For example, would you pay $50 for a banana from the grocery store tomorrow? Why not? Now imagine that you are someone that felt exactly that same way when the price of that banana is $0.50 cents instead of dollars.

Perhaps (especially looking at the now disappearing Great Depression generation, now reappearing anew from the Great Recession) the case is that the super savers have suffered some extreme poverty at some point to the extent that it affected their psyche and they are now terrified [consciously or not] of ever experiencing that again.

Perhaps the super savers in their 20s and 30s really are going to retire when they turn 35 or 40 in order to to participate in some leisure activity that they need to be physically healthy for (or by the time they have spent a decade not-spending find that they cannot break the habit).

Karin September 30, 2011 at 10:24 pm

I’m with Tim on this one. I probably qualify as a super saver at age 29. I bought a small house, drive a paid-off car, etc. Somewhere about 4 years ago saving just started to feel more pleasurable than spending. I still want things… But I’ve seen that wants are infinite. Kinda makes buying really cute new boots seem pointless. Your Money or Your Life was a big influence. I wonder sometimes if I’ll ever be able to turn off the saver instinct. Seems like a thin line between frugal and miser. The one area I really splurge is travel.

Julie December 10, 2011 at 12:29 pm

My parents gave me the best blueprint for retiring with enough money:

1. Take every retirement program you can whether offered by your workplace, association or the government (e.g. IRA)
2. Pay off your mortgage before you retire.
3. Pay off personal debt-such as credit cards!
4. Do not live beyond your means-ever.

It worked, even though I was in the arts and never really had anything like a steady income. Thanks, Mommy and Daddy.

BigSaver December 10, 2011 at 1:54 pm

Savings is a form of insurance. It is insurance against having your life blow-up if something bad happens. I was laid-off when I was 50 in an industry that is contracting significantly. That sucked. Trying to get a job or contract work is not going any better.

While working, I worked hard, enjoyed my job for the most part, saved a lot and invested reasonably well. By the way, to get better investment result than the vast majority of people is not hard or complicated.

Since my wife and I bought the insurance (saved a lot while working), we do not have to work another day. To tell you the truth though, I would rather be working.

I have never seen a retirement calculator that includes an option to have a major negative life event. Many of the people laid off recently that have been fortunate enough to find a job, have accepted jobs with incomes much lower than their previous one. Health issues can put a big hole in your savings in a hurry. By saving more now, you get to sleep better now and not be stressed out as much if things do go bad.

Lee June 26, 2012 at 3:23 am

Great article Pop :)

Mike June 26, 2012 at 11:59 pm

Thanks for the great article Pop :) , it is really true that we all must save for our retirement. I too started saving for my retirement from the last month. I know its too late, but before I was in huge debt and it can’t possible for me to save something for my future. I tried lot to get myself debt free, suddenly one day while surfing internet I came across to a Debt Consolidation Company, and believe me today I am debt free. Now I started saving for my retirement.

Andrea July 23, 2012 at 11:51 am

Saving money for retirement is altogether a debatable issue. It’s like you can’t have enough no matter how much you plan to save for the same. I feel a person should have a plenty amount of savings so that he/she can have a secured as well comfortable life post retirement. Thanks a lot for sharing this content with your readers.
Andrea Jones

DScot November 23, 2013 at 7:35 pm

Some people of the “herd” won’t want to get involved because by now many people are aware that not everything is what it seems. Believe it or not, many people are completely aware that “set-ups” are happening every day and all around. Not everyone is oblivious to the cultists of academe and their silly studies. Did you hear about those pigeons who found they could alter the behavior of lab technicians just by refusing corn pellets? Uh huh.

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