Is Saving Worth it?

The answer to the question that titles this post is an easy one.  The answer is yes, absolutely, yes.

Saving is fundamental to future well-being.  If you do not save today you will not be able to spend tomorrow.  This is especially true if your lack of saving today is coupled with borrowing.  When you borrow on a credit card to buy something today you are pulling future dollars to the present.  This creates both an explicit and implicit cost.  The explicit cost is the interest expense or annual expense the credit card company charges you to use their card.  The implicit cost is the opportunity lost to invest those dollars and earn a rate of return.

As your costs go up today your ability to cover your costs and live comfortably in the future diminishes.  For instance, if you do not save today and allocate those savings to intelligent investments then you will not be able to support your lifestyle in retirement.  So, from an individual’s perspective, what does it mean to save?  To us, saving and investing is done in the hopes of matching future expected liabilities to current and future expected portfolio values.  Once your working life is over, you then must live off your life savings.  If you failed to save enough then your retirement will not match the same standard of living you enjoyed while working.

Two options present themselves at this point.  First, you can either meaningfully cut back on your standard of living (i.e. no vacations, no gifts, no donations, no new clothes or cars).  When faced with this choice most people refuse to accept it.  Thus the second choice is to maintain your current lifestyle and run the risk of running out of money before you die.  This is an extremely risky proposition.  With the average life expectancy growing every year the riskiness continues to increase.  We find it odd that many people will make the statement, “I could die at any moment, I might as well live life to the fullest.  There is no point in saving.”  While, we agree that you could die at any moment the odds are certainly not in your favor.  It’s more likely you will live to 85 years old than not.  We have modern medicine and current social structures to thank for that.

Transitioning from warnings to assumptions and numbers provide a little more clarity.  For example, let’s say you are an individual and you are 40 years old (see the ‘Base Case’ in the chart below).  You currently have $100,000 in savings and you plan to work for another 30 years.  You also believe that if you had $100,000 per year in annual salary today then you would be able to live the life you exactly want. With an inflation assumption – this is the general growth in the cost of things we buy everyday and is a result of a growing and more productive economy – of 2%, and then we can say that you will need approximately $180,000 per year to live the life you want when you turn 70.  Now, using a very general rule of thumb, say you can only withdraw 4% from your portfolio per year in order to not draw down on the principal.  This means, in our example, you need a portfolio value of approximately $4,500,000 at age 70.  Wow!  Your current portfolio at 7% will only amount to $761,000.  You can only make up the difference by saving today, saving frequently and saving about $40,000 (if you can earn 7% p.a.). But what if you only makes $80,000 per year?  That is a savings rate of 50%.  Finally, what if you had started at age 25 and no savings, all else equal?  Well, you would only need to save $16,000 per year.  If you had a starting salary of $55,000 then that is only a savings rate of 28%, which much more achievable.

is savings worth it chart

The moral of the story is if you want to spend tomorrow you have to save today.  Saving today also requires a flexible plan and starting early.  We love the effects of compound interest and over very long periods of time it works wonders.  Make sure it works for you too.

Adam Wright

About Adam Wright

Ever since I switched into the Smeal College of Business at Penn State I have pursued intelligent analysis with all the vigor available to me. Joining Wright Associates in 2011 has provided me the opportunity to put years of education to work.