You Should Spend More and Save Less (Especially Grad Students)
The same episode of Freakonomics that I wrote about last week contained another segment that I thought worthy of comment here (and actually there is one more!).
Levitt told Dubner some advice that he received from an older faculty member when he was just starting out as a professor of economics: “You should spend more and save less. You’re never going to be poorer than you are today… Your salary would only go up and your earning power will only go up. So you shouldn’t be saving now, you should be borrowing. You should be living today in much the way you will be in 10 or 15 years and it’s crazy to be scrimping and saving.” Levitt says that this advice went against his own thrifty middle-class upbringing.
Far be it for me to question the PF advice economists might give each other, but unsurprisingly I think this is bad advice that makes dangerous assumptions. Thankfully, Dubner plays the voice of reason in the podcast, stating: “This sounds like some of the worst advice I’ve ever heard.” If young people want to apply Levitt’s advice, they should at least examine the underlying assumptions to determine if they are applicable.
The Temperament of the Individual
I think this advice needs to be put in the context of who Levitt was when he received it (and is now). In the podcast, Levitt states that his natural bent is to value material possessions at zero. “I care so little about money and I’ve always cared so little about money and I’ve never really wanted anything… Nothing’s really worth anything and you don’t really need anything.”
As an example of his application of the above advice, he says that he used to never buy anything in an airport on the principle that everything is wildly overpriced. But after listening to the anti-thrifty advice, he decided that he would allow himself to buy something in an airport if the price was under $5. Woah, big spender.
Perhaps we can say that given Levitt’s disinclination to spend money on anything, receiving the advice to spend more and save less was likely very helpful for him. He was way over on the tightwad extreme of the tightwad-spendthrift scale. And maybe it’s also safe to say that the advice would be good to pass on to other tightwads with Levitt’s similar earning potential (more on that next). But the majority young people who are not extreme tightwads should probably bother to examine what their actual rates of saving and spending are before skewing more toward spending and borrowing.
The Future Earning Power of the Individual
Levitt is looking back at his life having not only achieved the incredibly coveted (by academics) career of a tenure-track faculty member in one of the top departments in his field, but he has also had this incredible mainstream success with the Freakonomics books and other publications. Frankly, not everyone is going to have such career success. The “spend more, save less” advice has worked out for him in retrospect, but how many others who seemed to be in his same position back when they were in their 20s can say the same?
Dubner points out in the podcast that when Levitt was young he was investing in himself by attending graduate school and that his investment has been paying off ever since in his academic career, but most young people do not have the expectation that their earning power will increase at such a high rate. But Levitt counters that the earnings of college graduates generally will increase over their lifetimes, so the assumption is good for any college graduate.
I will just say to this assumption that an individual’s experience may differ greatly from the average, especially when the average is over all college graduates. Just as there are some fields that earn and grow far more than the average, there are some that earn and grow far less. The advice may therefore be safer for engineers than it is for fine arts graduates. This is obvious!
Someone’s personal choices may also impact his earning potential, and saving at a reasonable rate while you’re young (or at least not trying to spend more than is your inclination) gives you the option of taking a lower-salary path. Becoming accustomed to a high standard of living (especially when acquired through debt) virtually locks you into that higher-paying career path for a long time, even if you want to go another direction. I always keep in the back of my mind the possibility – because I have heard this anecdotally from so many other women – that I will want to take a break from work after we reproduce. I don’t know for sure at this point if I will or will not want to do that, but it certainly would be nice to have the option. Frankly, becoming disabled is another pitfall that happens to many workers. We don’t know the future and there are no guarantees.
Even for graduate students, who are certainly making a high investment in their futures, I would still argue that it is advantageous to save while in school because of how much those investments can grow (the time value of money).
The Value of Keeping a Constant Standard of Living
The only real rationale that I can see for giving this advice – aside from just wanting to enjoy consumption for its own sake – is that it is somehow beneficial to keep the same standard of living throughout adulthood. Borrow when you’re young to achieve the standard of living you can afford in your middle age, and then draw down you savings to keep it there until you die. I honestly don’t see why this is desirable. Kyle and I find satisfaction in living within our means – we are happy to see that we can thrive on our current low income and we’re looking forward to earning more in the future. When we do earn more, we’ll enjoy it – but not until. We prefer to use percentage-based budgeting to keep the fraction of our income available for spending the same throughout our life. That way we can ‘reward’ ourselves when we earn more while building the lifelong habit of saving.
If you don’t subscribe to the principle of living within your means, then perhaps there are limited circumstances wherein Levitt’s advice could be not terrible. Even so, I don’t see the advantage of following it. I also think it’s dangerous to give this advice indiscriminately to any college graduate and I’m glad that Dubner brought some skepticism to the conversation.
What do you think of Levitt’s advice? In what situations would you consider it good advice? What would you tell young people about their spending and saving habits? How about graduate students?
photo from Free Digital Photos
Filed under: career, grad school, savings, spending · Tags: college students, Freakonomics, grad students, saving, spending
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I don’t think his advice is crazy for most college graduates, it just assumes that he knows what young individuals want. Like you said, not everyone wants to be locked into earning an increasing amount til they’re 65. I feel like saving while you’re young is simply an insurance plan for if things go south in your 30’s. It’ll be a whole lot better to have a little savings than massive consumer debt.
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You are right that he assumes a lot about the advice recipients – that they want to work for several decades in a career with an increasing salary. Also that nothing will happen to derail that income. Like you said, saving is a way of self-insuring – even for later than your 30s! Although we don’t want to retire early, I think about all the people who are forced to retire in their 50s due to poor health.
The general problem I have with Freakonomics (and similar books/shows/sites) is that in order to seem novel and exciting, they often tell you that the conventional wisdom is totally wrong and the opposite should be followed. I have read so many attention-grabbing books where that is basically the premise.
But rarely is the conventional wisdom so far off that the opposite is true. The world is far too complicated for that to be the case. Instead, the conventional wisdom is partly right, partly wrong, and mostly overgeneralized. So a more useful discussion is one that examines the assumptions behind the conventional wisdon, and that also looks at when it is reasonable to apply it when it is not. I like how you’ve done that with this post.
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Thanks! I like digging into assumptions behind arguments. The analytical portion of the GRE was a joy. 🙂
I actually really liked Freakonomics, but I think the big difference between it and this FAQ-style podcast is that it was actually based on research instead of just Levitt spitballing.
I would not suggest people to spend all that they have. Although I know some people would love to hear the advice to spend as much as they want.
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That’s what I’m afraid of, too. Some people might latch onto this advice as justification for spending to their heart’s desire without examining the context of the advice.
I agree with you. It’s bad advice. I get the feeling that success has put him very out of touch with people who are truly struggling through their 20s or 30s (not “scrimping and saving” by choice).
As for his advice about “living like you would 10 to 15 years from now,” why not live like you do now in 10 or 15 years? The average family could save thousands upon thousands of dollars by simply avoiding lifestyle inflation as their income increases.
Yes, I think it is a very unusual young person who scrimps and saves and wastes tons of time doing it (another thing he mentioned in the episode) who doesn’t absolutely have to.
Very good point about the reverse way of keeping a constant standard of living. While I don’t aspire to this, you would be able to amass amazing amounts of money by banking all your raises.
I guess it might depend what you mean by “spend”… We borrowed as much as we felt comfortable borrowing to invest during the RE crash. We were “beyond our means” in some respects, in tht we paid it off much faster than we originally planned as our salary growth took off, but we weren’t buying a ton of depreciating assets or things that would make their way to the goodwill pile.
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The podcast gave no indication that they were talking about investing. He just mentioned borrowing and spending. A reasonable discussion can be had regarding borrowing to invest… but this discussion seemed pretty unreasonable!
This sounds like the sort of advice that an economist might give, because it’s rational, in a way, but kind of ignores the fact that human beings are not automatons. Getting accustomed to a higher standard of living in your early twenties isn’t necessarily going to translate to wanting the same, static standard of living for your entire life. A likely consequence for these college students is to follow the typical hedonic adaptation lifepath. As such, starting with a higher standard of living while young might just result in ever-increasing standards (nicer housing, cars, restaurants), but with a more expensive starting point.
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Correction, the type of advice a Chicago-school economist might give.
The rest of us understand behavior!
nicoleandmaggie recently posted..Emergency office supplies
I agree. I think it’s typical to want to increase our standard of living as we age, so starting it out artificially high is a recipe for disaster!
I haven’t taken the time to listen to Freakonomics, but this Levitt character is either an idiot, or more likely, is trying to push people’s buttons. Either way, I don’t think I will go out of my way to listen.
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I think he enjoys surprising people, but he’s so soft-spoken that I wouldn’t call it pushing buttons. But it is surprising that he would push this advice without qualifications.
I actually would recommend the book Freakonomics, though.
I’m a Phd economist from a top school and I have always thought that the idea of consumption smoothing over time is silly. 1. We don’t have perfect information, and we don’t know what negative (or positive) shocks we’re going to get. We don’t have perfect insurance, so we have to self-insure to guard against negative shocks that could cause low consumption. 2. People like having increasing consumption over time, not flat consumption. It is much more fun to increase your quality of life as you get older rather than having to cut it back. (Some of this may be because of how we view time horizons. It’s neat how psychologists and behavioral economists are really getting into these black boxes.) We get used to higher levels of spending and they don’t make us as much happier, so it’s good to stay at lower levels while they’re still not so painful.
Also, as you note, having a big savings cushion provides freedom to do many different things, like choosing a less lucrative career path.
nicoleandmaggie recently posted..Emergency office supplies
Unsurprisingly, you articulated that far better than I did! I didn’t know consumption smoothing was a thing, but like I said I don’t see the appeal. I’d rather increase consumption with time, too.
Yeah, it’s basic econ along with everyone being rational. Falls apart once you allow a few behavioral and uncertainty assumptions.
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But I guess I don’t understand why it’s irrational to not want constant consumption over a lifetime? Or if so, like Sarah said, why not make the fixed consumption level where you start out instead of guessing where you’ll be in 10-15 years?
Because of diminishing marginal utility. (See graph: http://nicoleandmaggie.wordpress.com/2011/10/24/marginal-tax-rates-why-they-make-sense/ )
You don’t just want any constant/fixed consumption– you want a constant utility that is going to be as high as possible given your total lifetime earnings. That’s going to give you the biggest bang for your utility buck.
That’s because you’re happier with two years consuming say 30K, than you would be consuming 0K one year and 60K the next year. (You’d also be dead if you did that.) The amount that 60K makes you happier than 30K is smaller than the amount 0K makes you sadder than 30K. (You can see that on the diminishing marginal utility curve– going down is steeper than going up. Each additional dollar provides less additional happiness, each dollar lost provides more additional grief.) Depending on interest rates etc., there’s going to be some optimal consumption level given your permanent income and the rate of return of your savings/cost of debt. And that’s going to be flat. (You can use a 2 period-model with interest rates to model this stuff. If you allow bequests you end up with an OLG model!)
However, people actually do prefer increasing consumption profiles, not flat. Additionally, there’s another set of theories dealing with the lifecycle hypothesis that suggests that people consume in a hump shape– ramping up through middle age and then down again once the kids are gone, and some beliefs that people prefer that. I dunno.
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I didn’t follow all of that explanation but thank you for taking the time to write it! It does seem a little silly to leave real behavior out of the theories and models.
What part didn’t you understand?
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I agree with you.. that’s just bad advice to me. I know older family and friends have constantly told me, “oh, don’t worry too much about what you make now – you’re earnings are always going to go up!” I thought that was crazy. There’s no law saying I’ll 1. always have a job, 2. never take a pay cut, and 3. always earn a raise every year. I don’t think it’s smart to count on future wealth. I’d much rather work now to build up wealth than rely on a better financial situation that may or may not be in my future.
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Yes, it is much smarter to try to build wealth than just assume it’s coming your way!
I honestly can’t see how his advice would be helpful in any circumstance. I think that you are far better off trying to save as much as you can for as long as you can. I think that younger people (myself included) have to be prepared for the reality that our income will not increase as quickly as in previous generations. The economic climate has changed for many of us and as a person working in a helping profession I can’t count on my income increasing a great deal. I share your hesitation about this advice. Thanks for your insight.
I still want to have a growth mindset and be hopeful about my future real-career income, but I don’t want to count on it to the extent that I sign myself up for debt or fail to save for the future. I think we will just adjust for whatever income we have and if it downgrades later we have to be prepared to downsize our lifestyle.
I listened to that while exercising and I think I might’ve laughed out loud. The guy with an economics PhD can say that, but I hope the guy with an MFA doesn’t listen! And depressing as it is, we have to be aware that most of the jobs being created today are NOT full time jobs with benefits (even for some kinds of engineers, according to a family member in the field), so I’m more cautious than optimistic.
As half of a grad student couple with an average age of 30, I’d LIKE our income to go up in the next 10 years, but I’ve seen couples tread water financially for years after graduation – whether because they have kids and childcare makes things tight for a few years, or because they can’t both find full time jobs in the same place and one person winds up earning much less than they’d like, or because the perks of grad school, like free health insurance and student loan deferment, now have to be paid out of pocket. Best to be prepared to face new challenges.
This does explain how I’ve noticed that my med student friends spend much more freely than my grad student friends though. They have nicer apartments, non-Craigslist furniture, go on trips and to expensive restaurants more often, etc. – it’s half fatalism because they’re taking out such massive loans for tuition that an extra $100 seems like nothing, and half counting on the fact that their income is going to increase by hundreds of thousands of dollars in a few years and they’ll pay it all back. Grad students are like, “Low income, better get used to it.”
You’re the first commenter who actually heard the podcast – cool! I’m glad someone else heard it and had the same reaction I did.
It’s a little disheartening to look at people like you have and see that the next career stage or even a higher income doesn’t necessarily translate to an easier time with finances because of other life transitions like moving to a higher cost of living area or having children. I am definitely not looking forward to paying health insurance premiums!
I agree that I see my professional school friends spending more freely and definitely think that fatalism plays into it. For many of them it’s an okay assumption that they will be able to out-earn their debt, but certainly not all specialties or all localities. I hope those that already know they are called to those lower-paying segments of medicine are living more like grad students!
I’m all for starting to save as soon as possible. The sooner you have money, the sooner you have options. If you start working in a job you hate and have no savings, your options are limited to either staying or finding another job. But if you have ample savings, you have the option to leave and follow your heart to see if it works out or not.
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Yes, you said it very well – saving gives you options, and that can be very valuable!
I kind of followed this in the last couple years as an undergrad. While career success is not promised, engineering majors had a good track record of long term employment. I realized it wasn’t worth it to make $10 hour while going to school when I’d make a lot more in just a couple of years. I also took out student loans in my last year for study abroad, recognizing it was an indulgence. Never again have I had so much time to travel and experience the world.
That said, there was literally no way i could have afforded college without any loans, so living “within my means” wasn’t possible.
In general i agree this is bad advice. Grad students usually receive enough to live on, and it is better to live within your means. Maybe save less than you eventually might, but it seems crazy to borrow a bunch of money when no one else in your social circle is spending any more than you are!
I think it’s a good argument if he was just talking about college students while they are in college, but not a good argument if talking about college grads. Certain types of student loans (/the people they educate) really pay off.
“You’re never going to be poorer than you are today… Your salary would only go up and your earning power will only go up”
If only that was always true. This year I’m on track to make only 2/3 of what I did last year, plus I’m spending close to $2000 more on gasoline. A lot of blue collar fields have similar issues. Due to changes in the industry, my father earns less today than he did 10 years ago, and his pay rate is higher now than it was then!
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A college degree doesn’t buy as much income increases and stability as it did when Levitt graduated, I think!
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