A New Paper Says Young People Shouldn't Save for Retirement. Advisors Disagree.

What the Model Says

The new analysis suggests retirement policy is often predicated on the belief that earlier saving is always better, thanks primarily to the power of compounding. This belief is used to justify the increasingly widespread practice of automatically enrolling workers in employer-sponsored defined contribution plans, the authors write.

Reactions to a Contrarian Conclusion

Speaking with ThinkAdvisor about the paper's conclusions, Amir Noor, director of financial planning at United Financial Planning Group, calls them "interesting and obviously not unfounded from a theoretical perspective." But at the same time, Noor says, financial advisors can point to some obvious concerns about the findings.

"Compounding of money has been referred to as the eighth wonder of the world," Staib says. "The value of it is significant, especially for those who are younger and save earlier in life, as it increases the number of years over which the compounding occurs. Let time do the bulk of the work."

Staib and Noor point out that saving at a young age also enables much more flexibility over time for altering personal spending patterns or pursuing an early retirement. These are things that most people value, they suggest.

"A savings mindset builds self-accountability and results in the saver being more self-sufficient and less dependent on other entities — company pension, Social Security, etc. — to fund their personal retirement," Staib says. "Inherently, saving reduces certain risks associated with relying on outside entities for one's retirement. There are also numerous behavioral benefits inherent in saving at young ages."

Mike Hunsberger, founder of Next Mission Financial Planning, says he would agree with the findings if humans were purely rational actors. In reality they are not, and like Staib, he worries that the paper ignores some basic facts about behavioral finance.

"In theory this is great, but in reality, it's not," he says. "I am a huge fan of starting early with saving and making it a habit. This is one of my core beliefs. The main problem I see with not starting soon is, who is going to ring the bell and tell them it's now time to start?"

Hunsberger notes that mid-career professionals in their 30s and 40s might have kids and higher costs for things like day care or sports activities. Expecting people in this position to pivot smoothly from a spending to a savings mindset is unrealistic, he says, even for those people who earn a significant amount of money year over year.

"Where are they going to find this extra money to start saving?" Hunsberger asks. "And, because they've waited, they now have less time for compounding to work, so they actually have to save more over the next 25 years to hit the same number. Again, it's a rational argument, but I think it's dangerous if it gains traction within the general public."

Jason Blumstein, CEO and founder at Julius Wealth Advisors, points out that, if one studies how wealth is created in the United States, it flows more directly to company owners versus workers.

"So, if you want to try to build sustainable wealth, you need to become an owner, and an efficient way of doing this, especially for low-income workers, is via owning publicly traded companies," Blumstein posits. "If you are a young worker but are not saving/investing early, you lose out on the power of compounding, which thus limits your optionality down the road."

By not saving early, Blumstein suggests, an individual will likely lack the flexibility to take the calculated risk to self-fund the starting of a business.

"I like to tell people that the #1 answer in financial planning is, 'it depends.' Thus," Blumstein says, "maybe this article is right, maybe it isn't. It's best to work with someone that truly understands what you want out of life."

Daniel Yerger, president and chief operating officer of MY Wealth Planners, says the study is interesting, but he worries that it ignores the core fundamentals and the interplay between the life cycle hypothesis and the behavioral life cycle hypothesis theories.

Yerger notes that both theories posit that young people engage in "dissaving behavior," i.e. taking on debt, early in their lives to do things such as attend college, buy homes and otherwise finance activities and assets that they cannot afford due to their low incomes (as compared to their future selves).

"In consideration of human capital theory (the dominant theory in explaining why people take on education loans and delay creating income), an argument that young people should not save for retirement misses the point," he suggests. "Young people have low incomes and engage in dissaving behaviors because they believe that they can obtain skills and qualifications early in their lives that will magnify future earnings."

Yerger points out that borrowing at low and moderate interest rates, as one often secures with student loans and mortgages, likely represents a lower lost opportunity cost than simply forgoing the long-term rates of return earned by the aggressive asset allocations viewed as appropriate for young people. Thus, young people absolutely should save for retirement, Yerger says, even if it requires more borrowing or use of credit in their earlier and lower income years.

Andy Gerhartz, a financial planner with Bridge the Gap Retirement Planners, says he will stick by the conviction that compounding is the most powerful phenomenon there is regarding money.

"Younger people have time on their side," he says. "The more time one has, the more powerful the compounding can be. There are enormous opportunity costs of not investing early, and that opportunity cost is the lack of compounded growth on your money. If you have nothing saved and nothing to invest, you are not able to build wealth. Simple as that."