When it comes to basic financial advice, ideas like investing in stocks for the long term and diversifying among different types of investments gather a wide consensus. So that's why I was so surprised when I heard about this advice from Freakonomics author Steven Levitt: Don't save too much.
According to Levitt, the rationale was that in his career, he could count on earning more and more each year, and therefore wouldn't need to stockpile money for the future, for hard times. However, he notes that he doesn't actually follow his own advice, because his wife makes sure that they put some money aside.
Why saving is good
It was surprising to see anyone advised to save less. Why? Well, because we should all be prepared for bumps in the road, for hard times. Even professors with tenure can end up wishing they'd saved more. They may find themselves with some massive, unexpected expenses, for example -- anything from a costly medical emergency to gymnastics training for a daughter with Olympic dreams. Or they might decide they'd rather do something else that pays less income. You just never know. If they're used to a comfy lifestyle based on two incomes, it's tougher to react to a financial crisis.
It's critical to have emergency savings, or at least an emergency spending plan. If you find yourself in need of considerable money, where will you find it? (Learn more about emergency funds.)
You also want to save and invest for retirement. And if you ask me, the earlier you start, the better. That's because the younger you are, the longer you have for your money to grow. Consider the impact of having started investing 10 years earlier for some typical stocks:
|
Stock |
Current Value of $5,000 Invested in 1988 |
Current Value of $10,000 Invested in 1998 |
|---|---|---|
|
Walgreen (NYSE:WAG) |
$118,421 |
$18,471 |
|
Target (NYSE:TGT) |
$114,667 |
$29,978 |
|
Nike (NYSE:NKE) |
$270,708 |
$41,875 |
|
IBM (NYSE:IBM) |
$30,069 |
$21,217 |
|
JPMorgan Chase (NYSE:JPM) |
$40,530 |
$16,770 |
|
Caterpillar (NYSE:CAT) |
$75,912 |
$38,984 |
|
Schlumberger (NYSE:SLB) |
$85,019 |
$48,608 |
Source: Yahoo! Finance.
Notice how even by investing just half as much money, you ended up with a lot more by starting to invest earlier. The extra 10 years gave you more time for your returns to compound. What that means is that you won't have to save and invest as much over your whole lifetime -- if you engage in a lot of front-loading, by starting early.
Regardless, when it comes to Steven Levitt's advice, I think I'll stick with Mrs. Freakonomics.
