By Kurt Wunderlich, CFA
People love life hacks. Everyone wants to know how they can do more with less. Hundreds of websites are devoted to scrimping and saving for people in their 20s, 30s, and 40s so they can leave their 9-to-5 job as soon as possible and hopefully live off passive income streams for their remaining years. Building the habit of paying yourself first and investing early is smart. Warren Buffett famously called compound interest the Eighth Wonder of the World, and the retirement planning space is full of great posters and diagrams showing the power of saving early and often.
We already know that there is no one-size-fits-all approach to investing. So, what if we took a similar approach to savings? Yes, we can agree that those who start saving earlier give their money more time to grow and increase their odds of having more financial flexibility later in life. Those who procrastinate on saving may have to sacrifice more in their later working years to prepare themselves for a successful retirement. The financial challenge we all face, then, is creating the right mix of living in the now and preparing for financial independence.
Rules of thumb exist as a starting point for a conversation, not as the end to one. Investing, saving, and spending are all personal decisions that should arise from who you are and your values. You may want to make your own deodorant to save $4 a month so you can travel the United States full time in an RV by 35. Or you may enjoy your career and one day want to own the family home where everyone comes to gather. The financial pie for these two scenarios is drastically different. But both can be “right” and even coexist. The key piece in each (or any) goal is a focus on aligning your finances to support your values.
To start, what is your top financial life goal? Your purpose drives the process, and your process drives the results. As James Clear says, “Every action you take is a vote for the person you wish to become.” Beginning with the end in mind – that is, your goal – allows you to visualize the life and financial outcomes you want. Now that you’ve visualized your future, what is the path to get there?
Starting to save early is a good habit and a vote for financial independence later in life. Saving nothing today is saying that tomorrow will take care of itself. The problem with passing off the responsibility to save to your future self is that slowly increasing your savings over time is a much more manageable lift than going from saving nothing to saving 20% of your paycheck overnight. The saving-large-chunks-at-once strategy requires noticeable disruption to your now-normal lifestyle, and you may not like or be able to stomach them.
A recent article discussed savings plans for professionals who expect their earnings to go up regularly and significantly throughout their careers, e.g., doctors, attorneys, software engineers, etc. The author argued against scrimping in your 20s and 30s, instead suggesting that you should opt to enjoy life while you are healthy and save the bulk of your money later in life. To demonstrate this point, the author runs two examples: The first is Carl, who saves $5,000 a year for 15 years starting at age 22 and who at age 72 has $1,435,362. The second is Carrie, who doesn’t start saving until age 38 (she waited 15 years) but does so for 35 years to come out with only $739,567 at age 72. Both illustrations assume a 7% return.
Proving Warren Buffett’s point about compounding interest, Carl saved fewer dollars than Carrie but ends up with nearly twice the nest egg thanks to investing for a longer period.
The author then alters the thought experiment for high-earning career professionals, where Carl and Carrie each save an additional $75,000 starting at age 38. Carrying out the math, Carl ends up with $12,528,872 at age 72 and Carrie is not too far behind with $11,833,077. The difference is still the approximately $700,000 from the original example, but the overall values are much larger and the percentage difference between them is greatly reduced.
The author asserts that Carrie happily took the tradeoff of having a bit less money in retirement for the additional experiences she had while young. And while the point about the utility of money at various ages is well-received, the fact remains that Carl prepared himself for the unexpected by saving early while Carrie traded stability for more adventure.
Let’s dive in a little deeper. Carl and Carrie took separate paths to get to a similar result in this second scenario. In the illustration, they encountered no bumps in the road and were able to save the amounts needed with no trouble. Unfortunately, life is not linear and savings and investment are not guaranteed to build at a steady upward tilt. In reality, Carl and Carrie each took on four buckets of risk in varying degrees: saving, spending, income, and allocation.
Saving involves when and how much you set aside to put the odds of a successful retirement in your favor. Carl has less savings risk because he started earlier. Spending is about the percentage of your assets that you use up each year, along with the length of time you think you’ll need to sustain your lifestyle. Carl and Carrie have the same spending risk given their time horizons are the same.
Income risk is high for Carrie, as her strategy relies on bunching her saving later in her career, while income risk is lower for Carl, as he started saving right away. If something were to happen to Carrie or if her lucrative career disappears, she could be looking at a much lower standard of living.
Finally, both Carl and Carrie have allocation risk. If they do not invest their savings wisely, chances are good that their assets will not be sufficient to support their lifestyle. Carl took on more allocation risk because his assets are invested for a longer period. Put another way, the snapshot you take at the end of a vacation does not capture the experience of the whole trip, much like how modeling savings strategies does not always incorporate the full range of risks that show up relative to when you start.
While Carrie took the risk that her income would continue at a high level or increase over time, she did have earning potential working in her favor. And should her career end up not looking quite as bright as she expected, she can make a career switch or return to school to improve her earning potential. Those who retire early may not have the luxury of reinventing their career or going back to school if retirement spending causes their assets to dwindle at a time when their peers are leaving the workforce. Carl took the risk that he’d be OK with missing out on certain experiences earlier in life with the goal of financial security later. Should he not be able to fully enjoy retirement due to health issues, he may look back on his decision and wish he was more like Carrie.
Each savings strategy comes with risk. The question for you involves which risks you are comfortable with taking.
About the author: Kurt Wunderlich, CFA®, CFP®
Kurt Wunderlich, CFA®, CFP®, is a client development advisor at Buckingham Strategic Wealth, where he works with a team focused on delivering an outstanding financial life planning experience that helps clients connect their money with their most important and deepest-held values.
Important Disclosure: The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth®. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice. Individuals should speak with qualified professionals based upon their individual circumstances. The analysis contained in this article may be based upon third-party information and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. IRN-21-2834
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