In between the happiness of Christmas and the promise of the New Year, permit me to introduce a sour note, a hint of a scold.  If you're like, well, almost everybody, you're not saving enough.  15% of each paycheck into the 401(k) is the bare minimum you can get away with, not some aspirational level you can maybe hope to hit someday when you don't have all these problems.  

I mean, obviously if one out of two workers in your household just lost their job, or has been stricken with some horrid cancer requiring all sorts of ancillary expenses, then it's okay to cut back on the retirement savings for a bit. But let's be honest: that doesn't describe most of us in those years when we don't save enough.

What describes most of those years when we aren't saving is normal life.  We moved.  We got married or had kids.  The kids required entirely expected things like food, clothes, and schooling.  Work was hard and we felt we wanted a really nice vacation.  Friends and family went through the same normal life stages that we were, requesting that we travel and bring gifts to the happy events.

These things are not an excuse to stop saving, for all that I have used these excuses myself from time (and regretted it later, at length).  The recession should have driven home some hard facts, but the nation's 3.5% personal savings rate indicates that these lessons haven't quite sunk in, so let me elaborate some of them.

1.  You cannot count on high asset growth rates to bail out a low savings rate.  In the 1990s, we believed that we could guarantee something like an 8% (average) annual return by pumping our money into the stock market and leaving it there.  The problem is, this may no longer be true. For the last few decades, there have been a number of factors pushing up the price of stocks:

a.  Low interest rates on bonds prompted investors to look for higher returns elsewhere

b.  People started believing that over the long term, equities offered a low-risk opportunity for higher returns.  Unfortunately in finance, many things are only true if no one believes they are true.  If everyone thinks that equities are low risk, they will bid away the "equity premium"--which is to say, the discount that buyers expected for assuming greater risk.  At which point, stocks no longer offer a low-risk excess return.

c.  Baby boomers who had undersaved started pouring money into the stock market in an attempt to make up for their lack of savings.

However, stock prices cannot indefinitely grow faster than corporate profits; eventually, you run out of greater fools.  And future corporate profits are going to be constrained by slower growth in the workforce as baby boomers retire, and by the taxes needed to pay for all the bailouts and stimulus we just did.  Unless there's a sudden boom in productivity--entirely possible, but entirely impossible to predict, or count on--there's every reason to expect that stock markets performance will continue to grow more slowly, and be more volatile, than we got used to.

We saw a similar cycle in houses.  A mortgage used to be a form of forced saving that gave you an (almost) free place to live in retirement and a little bit of value when you sold the house.  We didn't realize that a number of developments had been pushing up the price of homes:

a.  The development of the 30-year self-amortizing mortgage, which enabled people to pay a much higher price for a given house than they would have in the era of 5-year balloon mortgages.

b.  The baby boom, which increased demand for houses as they aged

c.  The run-up in inflation in the 1970s, which gave (relatively inflation-proof) real estate a boost--and then the subsequent decline in inflation (and interest rates), which gave people the illusion of being able to afford more house because the up-front payments were lower.

d.  More widely available credit, which let more people take on bigger loans

e.  The increasing value of (and competition for) a small number of slots at selective colleges, which put a rising premium on houses in good school districts

These trends gave people the illusion that houses were, in some fundamental way, an "excellent investment".  But they're risky in all sorts of ways: neighborhoods can get worse rather than better, local economies can stagnate, the style of your home can go out of fashion.  

Moreover, like the stock market, houses are still pretty expensive by historical standards, as this chart from Barry Ritholtz shows:

2011-Case-SHiller-updated (2).png

If you can't count on a steep run-up in asset prices to build up your retirement savings, that leaves you with one alternative: save a much bigger chunk of your income.

2.  People are still living longer in retirement.  The increases in life expectancy post-retirement aren't as dramatic as they were in the antibiotic era, but they're still creeping up.  That means that you have to take smaller sums out of the kitty each year, so that what you have left will be enough to live on.

3.  Government finances are extremely strained.  The Baby Boomers are about to dump an even heavier load on them.  That means yes, higher taxes--but it also means that despite their formidable voting power, retirements financed mostly on the public dime are very likely to get leaner.  Especially because birthrates are falling everywhere--which means that the supply of young, strong-backed immigrants to man the nursing homes will not be as ample as it is now.

4.  Employers are not kind to older workers.  I wish this weren't so, but I'm very much afraid it is.  People who say "I won't be able to retire" may not be given a choice in the matter.  Like most modern economies, we've cut a societal deal where you're underpaid in your twenties, and overpaid in your fifties and sixties . . . and as a result, it's very tempting to fire those overpaid oldsters when times get tough.

And once you're forced out in your fifties, it is very, very hard to find a new job of any sort, much less one that pays what you're used to.  Even if you're willing to take a big paycut to work a less prestigious job, employers are reluctant to hire the overqualified--particularly since 99 times out of 100 the overqualified 55-year old simply does not have the stamina or the life flexibility of the single twenty-somethings who are applying for the same job.  And physically, you may not be able to do many of the low rent jobs that paid your way through college: by the time you're sixty, you're quite likely to have back, joint, or skeletal problems that make it hard to stand on your feet all day or lift heavy objects.

The upshot is that you can no longer plan on "making up" anemic retirement contributions later.  You have to start making them--right now.

5.  Emergencies seem to be lasting longer than they used to.  Before the 1990s, unemployment used to crater sharply during recessions, then recover quickly along with demand.  We had our first "jobless recovery" under Clinton, and now we've got two more under our belt.  That means that the old advice of three to six months worth of emergency funds are no longer enough. 8 months to 1 year is more realistic.

When I write these posts, I generally get two types of responses:  people who smugly tell me that they are saving 30% or more of their income (way to go!) and people who tell me that it is simply not possible for them to save t15-20% of their income. 

You know better than I, of course.  But most of the research on consumer finance shows the same thing: people can usually save a lot more if they make saving a priority.  Most people don't.  Savings is an afterthought--it's the residual of whatever hasn't been spent on clothes, groceries, cars, dinners out, school trips, travel soccer team, college tuition, vacation, etc.  Unsurprisingly, there's frequently no residual.  However, if people decide how much to save, and then budget their consumption out of what is left, they suddenly realize that they could drive an uglier car, take the kids out of dance class, live with the kitchen the way it is, stay home for a week in August instead of going to Disneyworld, and so forth.  And those people are not, as you might think prospectively, made desperately unhappy by these sacrifices.  Savers are actually happier than the general population--in part, one assumes, because they're less worried.

Many people tell me they can't save because children are so expensive.  Children are indeed very expensive.  But they're getting more expensive every year, and that's because we're spending more money on them.  We're spending more money on houses to get them into good school districts, on activities so that they have every chance to get into Harvard (or the NHL), on clothes and cell phones and video game consoles and the list is endless, plus then there's that tuition to Harvard or some sort of even-more-expensive smaller private college.

These expenses are optional, not mandatory.  And before you tell me about how unhappy your child will be if you do not buy him all of these necessities, think about how unhappy he's going to be if you have to move in with him.  Better yet, volunteer for some outreach to the bankrupt seniors whose kids wouldn't let them move in, and see how their lives are going.

This is not to criticize.  Saving is hard, which is why, just like you, we're trying to figure out how to hit even more ambitious savings goals in the New Year.  And consumption is fun.  That's why most people struggle to save very much.

But a lot of people are going along on autopilot; they're saving 5% because it seemed safe when they were 25 and so what if they're now 37?  They look at the neighbors spending a fortune on cars and school activities and figure that if it's safe for them, it must be safe for me too.  But this is the opposite of the truth.  If your neighbors aren't saving much (and trust me, they aren't), that means a less productive economy in the future--and more people trying to claim a very limited supply of public funds. You don't want to be among them.

It helps to remember that the object is not to turn yourself into a miser; it's to make your spending patterns sustainable.  Your splurges will actually be a lot more fun if you know that they aren't putting you at risk of bankruptcy, foreclosure or a retirement in poverty.

If you're not saving enough--and you know who you are--don't decide today that you're going to save 15%, and then forget about it tomorrow when you realize how daunting a task that will be.  Instead, try this: divert an extra 5% of your income into a 401(k), IRA, or other tax-advantaged savings plan.  If your 401(k) is stuffed but you don't have much of an emergency fund--or if, for some reason, you don't qualify for tax-advantaged savings--have 7% of every paycheck diverted to a bank account which isn't linked to your other accounts.  It's a slow week at work, the perfect time to fuss with HR paperwork.

The important thing is to pay yourself first.  Savings should be the first thing you do, not the last.  After you've saved, then you budget your consumption. I won't tell you what to cut, because when you confront your new, slightly leaner budget, you'll be perfectly able to calculate what's no longer worth the money to you.  I think you'll be pleasantly surprised to find that after a few weeks or a few months of initial pinch, you won't remember that you miss the money much.

If at the end of the year, you still aren't saving enough, then you can do the same thing again--pull another 5-7% out of every paycheck.  Within a few years, you'll be at a healthy level of savings, without excessive fiscal pain.
