Most financial planners advise young people to start saving early for retirement to take advantage of the power of compound interest. New research, however, indicates that many young people should not save for retirement. Here's why:
Most financial planners advise young people to start saving early — and often — for retirement so they can take advantage of the so-called eighth wonder of the world – the power of compound interest.
The just-published research examines the life-cycle model even further by looking at high- and low-income workers, as well as whether young workers should be automatically enrolled in 401 plans. What the researchers found is this: “The economic model would suggest ‘Hey, it’s not smart to live really high in the years when you’re working and really low when you’re retired,’” he said. “And so, you try to smooth that out. You want to save when you have relatively high income to support yourself when you have relatively low income. That’s really the core of the life-cycle model.”“In the life-cycle model, we are assuming you are getting the absolute most happiness you can out of income each year,” said Scott.
In essence, Scott said, the current environment makes a front-loaded lifetime spending profile optimal.As for those with low income, say in the 25th percentile, Scott said it’s less about the “income ramp that really moves saving” and more that Social Security is extremely progressive; it replaces a large percentage of one’s preretirement income. “The natural need to save is not there when Social Security replaces 70, 80, 90% ,” he said.
“It’s optimal for them to take the money and use it to improve their spending,” said Scott. “It would be better if there weren’t penalties.” Not necessarily. “The person who is confused and defaulted doesn’t really know it’s happening,” said Scott. “Maybe they’re getting a savings habit. They’re certainly living without the money.”