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Published: Sep 02, 2022 6 min read

Good news, spendy young people. You can probably ignore the popular personal finance advice that says you must always save a certain portion of your income.

A new working paper by James Choi, a professor of finance at the Yale School of Management, explores how popular personal finance advice — like the directive to save early and consistently — compares to academic research by economists.

Choi read through nearly 50 of the most popular personal finance books from the last decade or so, including Robert Kiyosaki’s Rich Dad Poor Dad, Ramit Sethi’s I Will Teach You to Be Rich and three titles from each from finance celebrities Dave Ramsey and Suze Orman.

Choi found that for the most part, the strategies that economists say are optimal differ from the advice in popular personal finance books.

That’s especially true when it comes to advice about saving money. Popular wisdom says you should save a set portion of your income each month no matter how much you earn or where you are in life. Of the 50 books in the study, Choi found that 21 recommend saving a set percentage of money that remains the same as you age. Economists call that a “smooth” savings rate.

Most of those books argued for a savings rate between 10% and 15%, while a few recommended rates of around 20%. Personal finance writers like the idea of setting a consistent savings rate because it helps people develop good habits and allows them to start taking advantage of compound interest as early as possible. But economists say the advice is flawed.

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How much should you save in your 20s?

There's a simple reason economists say a smooth savings rate isn't necessarily a good idea: 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 at every age, either.

“Because income tends to be hump-shaped with respect to age,” Choi writes, “savings rates should on average be low or negative early in life, high in midlife, and negative during retirement.”

In other words: When you’re younger, you probably don’t earn much money, and your expenses tend to be relatively high. During this period of your life, it's natural to save less (or not at all), with the idea that you'll make up for it by saving more later on.

Most people enjoy higher earnings around middle age. This is when it makes sense to ramp up your savings rate. After you stop working, the ratio will shift again and you’ll spend down those savings.

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Choi found similar flaws when it came to popular personal finance advice about investing, taking out a mortgage, and more.

For instance, many experts recommend something called the “snowball method” when paying down debt. The strategy involves paying off your smallest debt first, then paying off the next-smallest and so on. Proponents like Dave Ramsey say establishing a pattern of success and being able to see your open accounts disappear early on is motivating.

However, economists would say that the best method to tackle debt is to start with the loan with the highest interest rate, regardless of the balance, because this strategy would result in the lowest net payment.

Emotions and personal finance advice

Choi acknowledges throughout his paper that the cold, purely economic approach can fall short in the real world. Authors like Ramsey talk often about motivation and habits. They stress the role that emotions play when it comes to money — this is the “personal” aspect of personal finance. Academics, on the other hand, tend to have a more analytical and dispassionate view.

In his paper, Choi gives some credence to the fact that humans are, well, human. We are creatures of habit and sometimes make decisions with money that aren't in our economic interest.

He cites David Chilton, author of The Wealthy Barber Returns, who discusses the drawbacks of foregoing savings when you’re young. The method “seldom works in the living room,” Chilton writes. “First, costs have a funny way of never stabilizing. Second, most people aren’t going to be able to transition from setting aside nothing to being supersavers at the flip of a switch. Psychologically, that’s just not realistic.”

So while saving money consistently when you’re young isn’t strictly necessary, establishing the habit can make it easier to save later in life. It’s all about balance.

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