New study questions conventional wisdom
The conventional knowledge that it is nearly always preferable for people to start saving and investing for retirement as early as feasible is now being called into question by recent research from the Journal of Portfolio Management.
According to the new analysis, retirement strategy is frequently based on the idea that earlier saving is always preferable, primarily because of the power of compounding. However, this assumption is frequently not measured against a useful standard, reported ThinkAdvisor.
The authors contend that a lifecycle model, in which rational people distribute resources across their lifespan with the goal of preventing significant fluctuations in their standard of living, would serve as a reasonable benchmark.
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After constructing and analysing a “lifetime savings consumption model,” the authors came to the conclusion that most young people shouldn't actually be investing for retirement.
Over the course of their careers, most employees typically see significant salary increases, the researchers noted. This is especially true for higher-earners who will be more reliant on private savings to sustain their quality of living in retirement.
For these workers, it is consequently necessary to spend all of their money when they are young and to begin saving for retirement only when they are in their middle years.
The analysis assumes that low-income workers obtain substantially greater Social Security replacement rates due to their flatter earnings profiles. The upshot: optimal early career savings rates are very low for this cohort.
The report also contends that low real interest rates provide the environment under which a front-loaded lifetime spending profile would be optimal.
On balance, the authors argued that subscribing to the early savings model of planning through automatic workplace savings plans may not be the best way to go. Even with employer matching, they said, the welfare costs of automatically enrolling younger workers in defined contribution plans can be considerable.
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Among their worries is that by putting their early income in a savings plan by default, a lot of young people wind up taking on hazardous amounts of debt or taking tax-inefficient withdrawals from their savings accounts to cover immediate expenses, leading to worse overall outcomes.
