(More Than) A Penny Saved is a Penny Wasted, In Which I Trivialize the Entire Industry of Financial Planning
Prescript: This article is by popular demand, having won our meta poll at the beginning of the year. I predict three categories of reactions to it: (1) This is obvious. (2) This is obviously wrong. (3) This is just the rationalization I needed to keep doing what I’m doing! If there’s a fourth category — people who change their behavior based on this — I will be flabbergasted and want to hear about it.
Here’s a ridiculous first world problem. In fact, it’s like a recursive first world problem: even in the first world it only applies to the minority of people who have more money than they’re entirely sure what to do with. The problem is saving too much for retirement. I’d like to propose a heuristic for deciding between saving and spending. It goes like this: spend your damn money. Except it’s not quite that simple.
Fundamental to the heuristic is this question: How much money do you want to have saved? Include all assets, such as equity in your house. In other words, what do you want your net worth to be? Factors for deciding that target might include future expenses like a house downpayment, or retirement. Also factor in whatever you consider a reasonable safety buffer, such as a year’s living expenses. If you agreed with our previous admonition not to buy things like collision insurance for your car then add an emergency fund. Whatever your criteria, you should be able to come up with a target amount. 
Now what to do with that target is not as simple as being super frugal until you hit it and then never saving another penny. But my first point is that if you keep obsessively saving past a reasonable target then you are, in a very literal sense, wasting money, by letting it sit as excess savings instead of doing something with it that makes your life better. If you can’t get your head around the idea of “excess savings” — equivalently, excess net worth — then I think you have a pathology that’s the opposite extreme of, say, me, or someone who is totally reckless, or someone with a gambling addiction. A hoarding mentality, you might call it.
What to Spend Money On
Before I elaborate on my proposal for how to decide between spending and saving I should be clear on what kind of spending I mean. I’m not advocating economic materialism or consumerism here. My favorite way to use money to improve my life is to find things I spend time on that I don’t like to do and outsource them. For example, don’t do your own taxes or change your own oil or clean your own house if you don’t enjoy those things.  Especially if you enjoy your job more than those tasks and your effective hourly rate is not much lower than (or is higher than) the hourly cost of the outsourcing. The opposite can also be true: if you can arrange to earn less doing work you enjoy more, that’s probably worth the lost income.
More generally, you should primarily spend money on anything that shifts your focus from the mundane to things that give your life meaning. Donating to charities that are meaningful to you is a great way to do that. Traveling to visit friends and family should rank highly for the same reason. Just ask yourself what makes life meaningful for you. Improving the world, having fun adventures, relationships with friends and family, satisfying intellectual curiosity, …
Retirement, Schmirement; Or, Why to Waste All Your Money and Die Broke
Having talked about what kinds of things you should spend money on, let’s talk about something you shouldn’t. Namely, ceasing all work at age 65 and traveling around the world for the rest of your life. Think about how extravagant that is. Not that I disapprove of such extravagance in principle. What I find ridiculous is sacrificing and scrimping and saving all the way up to age 65 in order to enable such extravagance.
My argument here boils down to this: carpe diem. Certain kinds of adventures you may not be physically capable of at retirement age, or you might be less able to enjoy them when you’re a bit more fragile. And don’t forget the possibility that you’ll die young. Or there could be a financial collapse that decimates the stock market and sparks hyperinflation, destroying your hard-earned savings. Or you could win the lottery, metaphorically or literally. Oh, yes, and there’s always the technological singularity (or more mundane technological explosions that change everyone’s level of wealth). In other words, there’s a real risk that if you scrimp and save till age 65, it could be for naught. It makes sense to have a bias for enjoying things now. So much so that it’s worth some amount of risk of being poorer than you’d like to be in retirement. The goal, as most economists will tell you, is to smooth your spending over your whole life.  In my opinion the risk of dying with too much money should be taken just as seriously as the risk of dying poor. After all, that excess money in old age represents forgone opportunities earlier in life.
Here’s another way to look at it. Why slave away till 65 and then switch to an extravagant lifestyle where you never have to work again? That should be strictly dominated by the strategy of, throughout your life, taking, say, a month of unpaid leave every time you accumulate several thousand dollars in savings. Of course that’s an oversimplification. For one, if interest rates are high enough then it’s worth the wait because of how much your money will grow if you save it. But right now (2011) interest rates are very low. It’s quite true that invested money grows exponentially. It’s equally true that the amount you should care about spending money in the future decays exponentially. 
“If I have to just subsist on social security at that point, so be it.”
One more counter-argument to my reckless advice: You need some worst-case planning for the possibility of being physically incapable of working. Well, you can certainly factor that in to your target net worth. On the other hand, if I’m so disabled that I can’t work, I probably can’t enjoy much either. If I have to just subsist on social security at that point, so be it. Not that subsisting on social security while too disabled to work is any fun, but it’s both unlikely and extremely costly to guarantee against.
As far as I can tell, the reasons people obsess over large retirement nest eggs are the following:
- Their sense of self-worth is tied up with their bank balance.
- They’re altruists with high value for leaving money for others (perhaps their heirs).
- They’ve grokked the mathematics of compound interest but not the corresponding (roughly identical) mathematics of future discounting. So they really believe it’s inherently crazy to spend $5 now that will eventually become hundreds of dollars if they invest it.
- Plain old OCD, like hyperfocus on their goal of retiring.
- Puritan work ethic gone wild.
Number 2 is the only legitimate one in the list and you should go ahead and factor it in to your target net worth.
To Buy or Not To Buy
I said that key to the decision of spending vs saving is choosing a target net worth, but that it’s not simply a matter of being miserly until you hit your target. Rather, I propose this principle: Pick your ideal net worth and follow an extremely gradual path that takes you there. Call it your Golden Brick Road.  It starts at your current net worth, gradually increases till it hits your ideal, then stays flat forever, or perhaps goes down as you get older and need less savings. (Ideally you use something like Quicken or Mint that can continuously output your current net worth.) Then just keep an eye on it. If you’re below your Golden Brick Road (approaching your target too slowly) then be more frugal. If you’re above it (approaching your target too quickly), party time. If you’re young and your Golden Brick Road will take decades to get you to your target (as I claim it should) then it means saving only a tiny fraction of your income.
Or maybe you have multiple targets and your Golden Brick Road takes you to $2k in savings in time for a big vacation next summer, then to six months’ living expenses in five years, and then to three years’ living expenses by age 70. I don’t think you should think too hard about these numbers (or, worse, pay for a financial planner to tell you what they should be). The future is quite uncertain so they’re going to be essentially pulled out of your butt no matter how much research you try to put into it.
“You should not be bouncing between tight-fistedness and cocaine/hookers too often.”
Another thing about the Golden Brick Road: it should be wide enough that you’re not actually bouncing between tight-fistedness and cocaine & hookers too often. In other words, you shouldn’t have to react drastically to unexpected expenses (or windfalls) — being within a reasonable margin of error of the dotted line to your target suffices. With practice, very small adjustments should keep you on track. If a big enough emergency expenditure or windfall does throw you off your Golden Brick Road you can always reset and start on a new gradual path to your target net worth.
I suggested that I myself am not terribly wise about money. In fact I often struggle with the question of how much I’m willing to pay for things and it tends to feel very arbitrary. I’ve heard advice along the lines of, if you’re spending $100/week on restaurant meals then ask yourself if you value that as much as, say, a Broadway show every weekend. If not, stop eating at restaurants. But that seems to really miss the point. What if I can afford both the meals and the Broadway shows? Simply comparing expenses to each other only helps you to decide what to cut out if you know you need to be more frugal. But how do you know if you need to be?
I view the Golden Brick Road idea as a simpler, more general form of a personal or family budget. It’s a simple way to tell you when your utility for everything (that money can buy) should be taken down, or up, a notch.
But a Financial Planner Could Help Implement This, Right?
Sure, just like you could hire an interior decorator to help you arrange your furniture. According to the Wikipedia page, the objectives of financial planning are:
- Finding direction and meaning in one’s financial decisions;
- Understanding how each financial decision affects other areas of finance; and
- Adapting to life changes in order to feel more financially secure.
I’m saying that’s all bullshit and you should just come up with a very rough number for your target savings and then follow a very gradual path to get you there. That’s it. Elsewhere on the Wikipedia page it talks about “maintaining and enhancing personal cash flows through debt and lifestyle management”. Please. Just stay on your Golden Brick Road. If you’re so clueless that that’s not enough lifestyle management  for you then I can’t imagine (warning: argument from personal incredulity) that you can afford a financial planner in the first place.
Of course financial planning has more practical aspects, like helping you choose where to invest the money you’re saving. I’ll glibly trivialize that by saying, just put it in an index fund  using a 401k or whatever IRA, for the tax benefits. It’s a little high risk but you’re already putting a lot into social security which has you covered for the very worst case (we may get screwed out of social security but probably not if you’re literally depending on it).
Finally, there are tax issues to worry about but that’s what a tax accountant is for.
On the other hand, you may just not want to think about the mundanities of IRAs or continuous monitoring of your net worth. Well, first you should know that services like Mint or Quicken make that stuff easier than you’d think. But if you still want to outsource it, I think a financial planner is overkill. I actually pay a friend (who I call my Minister of Finance) to deal with such stuff for me. She doesn’t have the expertise of a certified financial planner but she makes up for it by completely shielding me from ever having to think about any of this (except when I write elaborate blog posts about it). The overhead is far lower that way; I just give her all my passwords and say “do what I would do”.
“No Golden Brick Road is necessary to tell them the glaringly obvious: they should be spending less.”
Let me get back to the people for whom this has all been entirely moot. For most people, no Golden Brick Road is necessary to tell them the glaringly obvious: they should be spending less. In that case it’s classic akrasia — you know you should be spending less but when faced with actual purchasing decisions, instant gratification trumps your long-term best interests.  If that’s you, please refer to our previous article on akrasia and how to do what you want. It’s certainly naive as a general solution to poor financial decision making — it’s about being hyperrational about one’s own irrationality — but we’re now talking about people who read all the way to the end of Messy Matters articles.
Speaking of which, the prescript got me curious. So let me have it:
- Article from Pop Economics: Can You Save Too Much for Retirement?
- A retirement calculator based on the principle of consumption smoothing.
- Also by the author of the above tool, the book Spend ‘til The End.
- Classic example of traditional advice to seriously bulk up savings. (Summary: You want to stop working when you’re 60ish, right? And you don’t want to be dirt poor at that point, right? So here’s what you do: live as if you’re dirt poor from now till you’re 60. Problem solved.)
Suppose you have $n and every day you either spend a dollar (with probability p) or you earn and save a dollar (with probability 1-p). Also, you’re immortal, so this goes on forever. What’s the probability you’ll go broke (i.e., ever hit zero)?
Illustration by Kelly Savage.
Thanks to Sharad Goel, Bethany Soule, Uluc Saranli, and Alex Strehl for helpful discussions and critiques. Also to Melanie Reeves Wicklow, Nate Clark, David Yang, John Langford, Kevin Lochner, and Abe Othman. And to Patrick Jordan and Alex Strehl for the puzzle.
 The pedants among you may quibble that in theory there may be no such target since you’d update continuously upon gaining new information and new opportunities. Or, more to the point, sufficiently golden opportunities (or emergency expenditures, or even windfalls) could make you willing to deviate arbitrarily far from any pre-decided target net worth. That’s all true. Nonetheless, you can decide a very rough target assuming nothing crazy happens and use it as part of a practical heuristic for guiding spending decisions, as the rest of this article will explain.
 Many people have an ingrained aversion to outsourcing certain tasks. I say get over it. You’re paying for other people to churn your butter (or turn soy beans into tofu) and that doesn’t bother you. And if you work in an office building then you’re even (indirectly) paying for the janitors to keep that clean for you. There’s no fundamental difference between any of these ways that you do or could spend money to make your life easier. To emphasize the relativity of it all, consider this quote from Agatha Christie: “I never thought I would be so rich as to have my own motor car, nor so poor as I would not have my own servants.”
 In fact, if you’re willing to take this to its logical conclusion — as economists are wont to do — it’s rational to incur a bunch of debt early in life when you’re relatively poor and then gradually pay it off when you’re earning more. What I’m proposing is very tame and risk averse by comparison. Though economists do acknowledge reasons not to take consumption smoothing to its theoretical extreme. One reason is imperfect credit markets. (Here the reaction is: let’s use government intervention to make it easier and cheaper to borrow against presumed future earnings!) Another reason is simply that you should account for the risk of earning less in the future than you currently expect, thus tempering your otherwise reasonable inclination to go massively into debt when you’re earning much less than you will in the future.
Though I will say that a lot of people have a rather irrational fear of debt. Your net worth is just a number that can very well be negative and nothing magical happens as it crosses the zero line. Except that you’re more likely to get taken to the cleaners on interest rates, of course. But if your debt is in the form of student loans or a mortgage, no problem. (A mortgage shouldn’t even be thought of as debt at all, since it’s fully collateralized. Ok, there have been exceptions since 2008.) As I’ll soon explain, your debt just means a longer or steeper path to follow till you reach your eventual target net worth.
 Actually comparing the value of investing (compound interest) with the cost of waiting is hard but one way to try to do it is to convert interest rates to doubling times. For example, consider a quantum of utility, maybe a weekend ski trip. What’s better, one such trip this year or two such trips in 14 years? I’m inclined to prefer the one trip now, but shrink that 14 years much and I’d flip. Well 14 years corresponds to a 5% interest rate. (The general formula is: doubling time in years = ln(2) / r, where r is the annualized interest rate. And ln(2) is about 0.693.) So for me, if (risk-free) interest rates are below 5% then, at the margin, I prefer spending to investing. If they’re much above it, then it’s the other way around.
 This sounds suspiciously like yet another plug for Beeminder but in fact there are no plans currently to support financial goal-tracking there, at least not with auto-integration with Quicken/Mint/etc, without which it would probably be too cumbersome.
 Tangential tirade: Managed mutual funds are always tantamount to a scam. It never pays to pay someone to pick stocks for you. The numbers you might be quoted that would make it seem otherwise are meaningless due to survivorship bias: Start thousands of mutual funds, then make all the unlucky ones silently disappear. The survivors can now quote impossibly good historical returns. “Past performance is no guarantee of future results” isn’t strong enough. Past performance isn’t even an indicator of future results when that kind of filtering has gone on. Hence, index funds. Which is pretty conventional wisdom (and James Miller on Overcoming Bias makes the argument particularly succinctly) unless you’re talking to a financial planner whose livelihood depends on making it all sound as confusing as possible.
 There’s another category of people for whom none of this applies: those eking by because they have no other choice.