Are We Over-Saving for Retirement?

There was an article in the Saturday New York Times (1/27/2007) that really got me thinking. It was called:

A Contrarian View: Save Less and Still Retire with Enough

I must admit, my initial reaction to the title was extremely negative. In a country where private pensions are quickly becoming a thing of the past, and Social Security continues to float in a bizarre state of political denial, telling Americans that they need to “save less” seemed irresponsible, bordering on criminally negligent.

The article didn’t initially endear me either with its analysis. Witness the third paragraph:


A small band of economists from universities, you say? No names, of course, of either the economists or the universities. But it’s good to know they are in a band, albeit a small one. Maybe they work with Robin Hood, and his merry band of thieves.

Of course, it’s rare for the New York Times to be this shoddy with reporting, so I move on through the article.  And it turns out, the article does have a point.  Look at the graph that was included with the article:


Aha!  Real sources, real numbers, and credible analysis.  It turns out, this is a legitimate piece, just written in a fluffy, air-headed style.  There is real financial analysis here to this question, and there are some issues raised by it which are worth considering.

One of the biggest innovations in personal finance in the last decade has been quick and easy access for individuals to sophisticated planning tools that previously were only available to professionals.   For example, many people used to just take a basic percentage of return, like 8%, and then project what their savings might be by the time they are 65.  (In fact, many people still do.)

Now people have access to tools, like at Financial Engines,  that do Monte Carlo analysis.  Monte Carlo analysis, like it’s name-sake city, is focused on risk & gambling. With Monte Carlo analysis, the computer will run through thousands, if not millions, of randomized versions of the future, based on the historical performance of different asset classes like stocks, bonds, and cash.  These simulators don’t tell you how many dollars you’ll end up with when you turn 65.  Instead, they give you probabilities you’ll end up with “enough money”, however you define that.

This New York Times article didn’t go into too much detail, but based on the tidbits in the piece, my guess is that the “band of economists” are focusing on a few ways that these models could demand “over-saving”:

  1. 1929-1937.  All Monte Carlo simulators worth their salt include, as part of their randomization programming, historical extremes, like the Great Depression.  In fact, the book I read by Ben Stein constantly refers to this period as the ultimate measure of a good strategy.  However, is it prudent to base your planning on what seems to be more and more of a historical outlier?
  2. Social Security. Almost all calculators that I’ve seen tend to evaluate your portfolio with no assumption of Social Security.  Now, I’m personally pretty negative on the idea that I’ll be collecting anything resembling the currently promised Social Security benefit, but in fairness, if you took the US Government at face value, that promise is worth a significant chunk of change.  Roughly $812,000, if you buy my earlier analysis.
  3. 85% of Income Needed.  Almost all planning tools tend to estimate your needed income in retirement as 85% of your pre-retirement income.  This assumption is actually based on the idea that normally you save 15% of your income, so when you retire and you stop saving, you don’t need that 15%.  Fine.  But this assumption is likely faulty in two regards – first, it likely differs based on your expected lifestyle in retirement (travel, health), and second, it’s unlikely to be a flat 85% through the rest of your life.

So, there are points to be made here, and it is something to think about.  I personally have been faced with difficult choices for saving that don’t have immediate, obvious answers.  What do you prioritize – saving money for a larger house & family, for retirement, for college, or travel & family fun?  What’s the right balance?  There is some truth to the fact that you could, in fact, over-save for retirement, and miss out on your life with your family while you are young.  You could live to 125, but you also could also die tomorrow.  I’ve had close friends and mentors who have died before ever seeing retirement, so these aren’t just theoretical questions.

In the end, I probably agree more with critics that say that the last message Americans in general need to hear is anything that sounds like save less.  No, in general, Americans are already getting an A+ in that class.  They are getting a D right now in save more, so while their are nuances that are worth discussion here, this article was the wrong way to present them.

As personal finance tools grow more sophisticated, however, it is also worth noting that in the end, they are just tools.  Garbage in, garbage out.  If you put in bad assumptions about the market or your goals and values, you will get bad answers out.  Sure, they’ll look pretty.  But they won’t steer you toward happiness.