When Saving Beats Investing for Retirement

The title of this post – when saving beats investing – may provoke controversy and/or complaints of “it can’t be done.”  That’s OK – it is a topic I am interested in pursuing anyway. What I will argue here is primarily for those who are close to retirement and are highly risk averse. These are the folks that have managed to put away a decent sized nest egg that, with a few more years of work and avoidance of losses – can allow them to retire with reasonable safety and a decent standard of living. We are in that category. So what do I mean by asserting that saving can beat investing?

Let’s start with a very simple hypothetical.  You have a retirement plan in place that says that you can retire in five years if, at that time, your retirement nest egg is at last $400,000.  Today your nest egg sits at $350,000, invested in a combination of stock funds, bond funds, and cash equivalents. Therefore, you need to increase that nest egg by $50,000 over the next five years.  You are currently allocating $5,000 per year of your income to retirement saving.

Assuming that your contributions remain the same and your investment returns are flat (which could be a good outcome under prevailing market conditions), your nest egg will come up $25,000 short. You can’t retire as planned.

For some, the advice given may be to take more risk so that your investment returns can fill in the $25k gap.

But we don’t want more risk, do we? We want to retire in five years, for sure, not just if our investment gamble pays off.

So what else can we do?

We can cut spending and save the difference.

Can you cut $25,000 out of your spending budget?  I bet you can. That’s only $417/month for five years. How hard can that be? That’s about the size of a typical car payment.

There are plenty of ways to cut monthly spending. I know, because we have implemented many of them. Our bloated cell phone plans are gone – replaced by $30/month pay as you go plans. Our land lines are gone. We have refinanced our mortgage. We don’t have car payments – we keep our cars for 12-15 years.

I’ll bet a lot of folks can cut out huge chunks of spending just by eating out less.

But wait, you like eating out a lot?  So do I but I like a retirement plan that is guaranteed to work even more.

But wait, you might ask, what if our current nest egg loses value while we scrimp and save more to fill that nest egg gap? We will still end up short!

The answer to that objection is simple. Because you have increased your savings rate, you can cut – actually eliminate – your investment risk.  Specifically, you can move your nest egg into non-risk investments. e.g., cash equivalents.  In an IRA, that could mean CD’s or Treasuries. In a 401(k) account, that may mean using a stable value fund.

But wait, you say, won’t I miss out on market gains if I do this? Wouldn’t that be bad?

Yes, you will miss out on market gains (if there are any over five years or whatever your short term retirement horizon is) but that is neither good nor bad. It just is.  If you don’t need market gains to assure that your retirement plan will work, why do you care about them if the payoff is no risk?

Remember, the goal is to retire in five years with a $400,000 nest egg, not to be a successful investor.

On the other hand, you will definitely miss out on potential market losses, and that is unquestionably good.

Look at it this way. Using my hypothetical, by spending $5,000 per year less and saving it for retirement, you will have increased your retirement nest egg by $25,000 over five years, without taking any additional risk.   For your existing nest egg to do the same thing, it would have to increase in value by approximately 7.1% over that same five years (excluding for simplicity the effect of your other contributions).  That’s not much but it requires taking some risk.

(A five year CD at current rates will get you there, but that means moving all of your retirement nest egg into CD’s.  Most folks can’t do that in an IRA or 401(k) plan.)

What about inflation, you might ask. Don’t I need to worry about that and doesn’t market investing solve my inflation problem?

You do have to worry about inflation. Therefore, while you are increasing your savings rate and decreasing risk, us that extra savings to buy I-Bonds. While I-Bonds currently pay 0% on the fixed interest rate component, the inflation adjusted interest component provides significant protection. In fact, if you embrace this “saving beats investing” concept, you can divert funds now being contributed to an IRA or a 401(k) and also use that money to buy I-Bonds.  You will pay taxes on the income used for the contributions but taxes on the interest earned is deferred.

But wait, you will ask, why would I want to pay taxes on that income now?

Well, the question is not whether you want to (no one does), it’s whether it makes sense to do it.

Tax rates are going up – there is no way around it – so you may be better of paying your taxes now. Also, when you eventually cash the I-Bonds for retirement income, you will pay federal income tax only on the interest.  Interest on I-Bonds is not taxable at the state or local level. This gives you more control over your overall tax situation each year when you are retired.

And don’t forget that tax deferred investments such as I-Bonds are not subject to required minimum distribution rules. You can hold them for 30 years and cash them out when it makes sense to do so.

Every scenario is different and only you will know if the concept of “saving beats investing” works for you.  When you actually retire, you will have to revisit your income model and perhaps add risk back to your plan.

Saving your way to your nest egg goal is certainly worth considering, don’t you think?


  1. Marius de Jess says

    Tell me, I am retired already and 75 years old, what investment can I go into so as to outstrip inflation, and still gain money for my daily expenses.

    Marius de Jess

Leave a Reply

Your email address will not be published. Required fields are marked *