Tuesday, January 30, 2007

Optimal Saving?

Some students of mine referred me to an article by Damon Darlin in Saturday's New York Times which merits a Voxy for posing the question:


That's a fascinating question, and the article goes on to quote some of the economists who have done very interesting research on it, including Karl Scholz of Wisconsin and Larry Kotlikoff of Boston University. Here's the crux of the matter:



Here are the excerpts from the researchers:
The economists answer that people would get more out of their money by using it when they are younger. “There is risk in saving too much,” Mr. Kotlikoff said. “You could end up squandering your youth rather than your money.”



I think some of the confusion in the article is due to a focus in the financial planning community on how much people are saving rather than when they do it. I think typical households are forward-looking but very impatient. That they are forward-looking means that they will enter retirement largely without surprise or regret about what they can afford. That they are impatient means that they will delay most of the saving that will get them to that level of comfort until retirement is just a decade or so away.

So if you see a 50-year old with not that much in savings, how do you decide whether that's a 50-year old who is optimally waiting to save a lot over the next 10-15 years or a 50-year old who does not recognize the need to save for retirement?

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