Economist confirms it’s actually ok to not save money in your 20s

Good news, splurge young people. You might ignore popular personal finance advice that you must always save a certain portion of your income.

In a new working paper, James Choi, a finance professor at the Yale School of Management, examines popular personal finance advice — such as the directive to save consistently early on — compared to academic research by economists.

Choi has read through nearly 50 of the most popular personal finance books of the past decade or so, including Robert Kiyosaki’s rich dad poor dadRamit Sethi’s I will teach you to be rich and Financial luminaries Dave Ramsey and Suze Orman took home three titles each.

Choi found that what economists say is the best strategy is largely different from the advice in popular personal finance books.

This is especially true when it comes to advice on saving money. Popular wisdom says that no matter how much money you make or where you live, you should save a portion of your income every month. Of the 50 books in the study, Choi found that 21 recommend saving a certain percentage of money that is the same as your age. Economists call this a “flat” savings rate.

Most of these books advocate a savings rate of between 10% and 15%, while a few recommend a savings rate of around 20%. Personal finance writers love the idea of ​​setting a consistent savings rate because it helps people develop good habits and get them started taking advantage of compound interest early. But economists say the proposal is flawed.

How much should you save in your 20s?

Economists say a flat savings rate isn’t necessarily a good idea for one simple reason: You don’t make and spend the same amount of money at all stages of your life, so you don’t need to force yourself to save the same amount for each age group , either.

“Because income tends to hump with age,” Cui wrote, “on average, savings rates should be low or negative early in life, high in middle age, and negative in retirement.”

In other words: When you’re young, you probably don’t make much money, and your expenses tend to be higher. It’s natural to save less (or not to save at all) during this time of your life because you’ll make up for it by saving more later.

Most people enjoy higher incomes around middle age. This is the point of raising the savings rate. After you stop working, the ratio will change again and you will spend those savings.

Choi found similar flaws when it came to popular personal finance advice about investments, mortgages, and more.

For example, many experts recommend a method called the “snowball method” when paying down debt. The strategy involves paying off your smallest debt first, then the next smallest debt, and so on. Proponents like Dave Ramsay say building a successful model and being able to see your open accounts disappear early is an incentive.

Economists would say, however, that the best way to deal with debt is to start with the loan with the highest interest rate, regardless of balance, as this strategy results in the lowest net repayments.

Emotional and Personal Finance Advice

Choi acknowledges in his paper that a cold, purely economic approach may fall short in the real world. Writers like Ramsay often talk about motivation and habits. They emphasize the role emotions play in money – the “personal” aspect of personal finance. Academics, on the other hand, tend to have more analytical and dispassionate views.

In his paper, Choi puts some credit in the fact that humans are human. We are creatures of habit and sometimes make decisions with money that is not in our financial interest.

He cites the author of the book “David Chilton” The rich barber is back, Who discussed the aforementioned drawbacks of saving when you were young. Chilton writes that this approach “seldom works in the living room.” “First, there’s an interesting way that costs are never stable. Second, most people can’t switch at the click of a button and go from nothing to a super saver. Psychologically, it’s unrealistic.”

So, while it’s not strictly necessary to keep saving money when you’re young, making it a habit can make it easier to save later in life. It’s all about balance.


Dollar Scholars

Still learning the basics of personal finance? Let us teach you the main money lessons you need to know. Get helpful tips, expert advice and adorable animals in your inbox every week.

Sign up


More from money:

Your emergency fund may be too small right now (thanks, inflation)

Down Payment vs Student Loans: How to Decide Where to Put Your Money

Average credit score didn’t rise this year — for the first time in more than a decade

© Copyright 2021 Ad Practitioners, LLC. all rights reserved.
This article originally appeared on Money.com and may contain affiliate links to which Money is compensated. The views expressed in this article are those of the author and not of third-party entities, and have not been reviewed, approved or otherwise endorsed. Offers are subject to change without notice. For more information, please read Money’s full disclaimer.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the views and opinions of Nasdaq Corporation.

Leave a Comment

%d bloggers like this: