What age you should start investing?

Drumroll…

“It depends!”

Who could have guessed, uh?

This is a very interesting and very complex topic. Interesting because, if you nail it, your future self will be very happy. Complex because there is no universal answer (beware those people that tell you otherwise) and the right conclusion depends on multiple inputs, some of which are outside your control. In fact, it is so complex that I am not sure how to best structure this post…

I have mentioned in this blog, here and there, my personal experience and my convictions. Today’s approach will be again less quantitative and more qualitative, in part because I am lazy but also because numbers can give the reader a “false confidence”. As the long-time blog stan might recall, we do not live in an Excel spreadsheet. It will be a Russillo-Life Advice type of content, if you want: gut feelings backed by my experience and knowledge.

Most likely, you will find YOUR answer when it is too late. No, not on your death bed but later than optimal. It is fine.

Why do you save?

I am going to murder it but the concept of saving is basically linked to the concept of an intertemporal utility function or intertemporal consumption. Let’s take a simple model based on the following premises:

  • individual preferences determine the amount of utility people derive from the goods and services they consume
  • consumers face constraints on their choices (budget, laws, etc)
  • consumers maximize the utility they receive from consumption, subject to the constrain they face

Consumers buy the goods that give them the most pleasure, subject to the constraints that they cannot
spend more money than they have. As a consumer, you must allocate your money to buy a basket of goods.

The static and basic version of this model is your monthly budget: your salary represents the constraint and you allocate it in the way it gives you the highest utility. Easy peasy: assuming your salary is comfortably above your basic needs (rent, food, utilities), deciding how to spend the extra money should be quite straightforward. You know if buying another pair of shoes gives you more happiness than a night out with your friends…and if you realize you made the wrong choice, next month you will re-adjust.

[I know not everyone is in this situation, but this is a post about saving. If your budget cannot cover your basic needs, then you are facing a very different problem.]

When we move from a static to a multi-period model, things get more complicated. Way more complicated. A multi-period model means the consumer can now save and borrow, move constraints from one period to another. In this context, saving is a form of consumption: the utility you get represents the additional freedom you will have in the future.

Multi-period

This is when things start to get tricky. Given a SET consumption basket, for example a basket that only contains beer, its utility function per dollar spent looks like this:

The consumer gets a lot of utility for the first beer but then any additional beer (or $ given that beer has a fixed cost per unit) provides less utility. This utility decay is not linear and you probably already know it; if you don’t…I bet you do not like alcohol or your parents never forced you to smoke an entire pack of cigarettes when they caught you smoking one.

The consumer can now choose between baskets that contain X beer today and Y beer tomorrow, all baskets constrained by the budget, or B = X + Y. With a constant budget, this problem does not make sense: why the consumer should not buy all the beers today if tomorrow they would have the same budget?

We need an additional element for our analysis, enter the shape of your budget through time:

in this graph, retirement represents the minimum income you get when you do not work, either as social security or as forced (by law) savings

If the consumer wants to consume X, the same number of beers, in every period and he knows that their future budget during retirement is B<X, then allocating something to Y makes sense. This mirrors real life, where the average person wants (or desires) to maintain during retirement a lifestyle close to what they had when they were working.

In reality, this problem is complicated by two further factors: we do not know what will be our budget tomorrow and we do not know how much utility we will get from one beer in the future.

Why this is relevant? The steepness of the curve determines your propensity to save in the early years. Take a doctor in the UK: after 5 years of medical school, they spend 10 years earning between £30k and £50k. But once they become Consultants, the sky is the limit in terms of salary, depending on their skills, specialization and willingness to work in the private sector.

At the beginning of their career, doctors work like horses and earn a relatively small amount compared to what waits for them later: why they should save and make their early life even worse? (For US doctors, the curve is even steeper) If I understood correctly, they also have a very good deal in terms of State pension, so the retirement gap they have to fill is smaller than normal (assuming the UK won’t default, obv).

But if you are a bus driver or a teacher (not sure if those are the right examples for a profession where salary increases are quite poor) if you decide to save (more on this later) then it makes sense to start early:

How high (and how early) you want your retirement budget determines how much you should save during your working life. There are certain experiences/items in which utility degrades quite fast the older you are. Setting aside how stupid it is to own a motorbike (if your goal is to live the longest possible), riding one in your 20s brings you more utility than riding one when you are 50; same thing for a trip to Ibiza with your friends. Or at least, that’s how someone might feel and therefore it would make sense for this person that an extra $ above basic needs in the early working years has more utility than one during retirement. On the other side, someone else might be more interested to retire in their 50s instead of their 60s.

What about expenses?

Articles that state a specific age range when you should start saving also assume that everyone’s life follows the same path expenses-wise, and that is obviously wrong. Finding a life partner, having kid(s), going through a divorce and receiving an inheritance are all events that have a big impact on anyone’s saving capabilities.

Assuming that everyone faces the same events at the same age is naïve at best, especially when you talk about children. FFS by the time I graduated there were lads here in London, my age, that were in their third year of investment banking; I did not choose to follow the Italian school system, it is what I got. (Thank God now the rules are different).

A month of childcare in London cost like a lease on a 911: your “by your 30s, you should have saved £XYZ” shames equally the parent and the car owner…not exactly fair, innit?

The single vs in-a-relationship status can impact your finances a great deal, even net of the tax advantages (or disadvantages, if you live in Switzerland). If you are single by choice, great, it was your choice. But more often than not, this is another aspect where luck has a great impact on someone’s life. And not, why don’t you get a roommate instead is not the solution (unless your favorite movie has Will Ferrell as the protagonist).

Why the concept of utility is important

When I studied microeconomics at uni, I found the utility theory too far from reality, too abstract to be of any practical use. Now, when I think about savings, the first concept that pops into my mind is utility.

Let’s go back to the beer example. From my 20s until probably too late, every night that I went out with my friends followed the same arc, drinking-wise. At first, I drink because I enjoy it and it enhances my mood. Then, I continue to do it way past the point where it makes any difference, especially on the positive side of things. In the moment, is really hard to pinpoint which drink is the “one too much”. But the day after, you definitely realize that you should have stopped (sometimes, waaaay before you did).

Those last drinks have zero, even negative utility.

It does not take a genius to extend the same concept to basically everything else you spend money on. That’s when you should stop spending and start saving. Yes, this will not win the Tony Robbins advice of the year, but it should at least let you identify that you reached the point. That’s the conclusion I reached about myself. On the financial side of things, I regret very few decisions I did in the past (trades excluded, obviously. There the list of things I should have done differently is almost infinite). But it is really hard to justify those drinks or how they led me to spend the days after.

Talking about alcohol, years ago Nick Maggiulli wrote about one of his rules on how to save. Every time he buys something that is not essential, like a $200 pair of sneakers, he taxes himself and puts aside the same amount as savings. While the rule has the advantage to be really easy to implement, I find it too frugal. You should not feel bad for the first pair of not-strictly-necessary shoes you buy; the second, third and fourth pairs are the ones should punish yourself for. It is the utility curve again 😉 Therefore instead of using a fixed tax amount, I would start low and then increase the more you “sin”.

10K words and not a single practical advice?

Didn’t I warn you at the beginning of the post?

I should have clarified this since the beginning but everything in this post is about savings ABOVE an emergency bucket. Having funds, or insurance policies, to cover mild to catastrophic risks should be your priority no matter your salary or age (your parents/family are a form of insurance policy, depending on the relationship you have with them).

The best advice that I have for you is to surround yourself with interesting people that do not care about money. Even better, people that see money as freedom, as optionality, not something to convey status. Nothing drives you more to extend your budget than keeping up with your friends. I am guilty as charged, since I spent quite the amount for our wedding and, while 80% of it was definitely for our memories, a part was to match our friend’s weddings. And another was to show off to my hometown friends. Easy to write, difficult to do. Since it is normal when you make money to spend money.

I will now list some reasons why it does and it does not make sense to start early to save (beginning from the latter since everyone else focuses on the former). They are the two sides of the same coin, where it lands depends only on you.

Why it does not make sense to start early

If you are at the beginning of your career, the only thing you should focus on, financially speaking, is how to increase your salary. That’s it. If you are researching tricks for saving, you are wasting your time, really. The median annual salary in the UK is £38k (before tax), an amount that does not leave exactly a lot of room for savings unless you can be really frugal. Any increase you score above the median will help your final saving pot more than any additional years of frugality. Networking is one of the most effective ways to increase your salary: if, for example, you skip an event because it does not fit your budget, your saving plan might even prove to be counterproductive.

Compounding is the reason why the earlier you start investing, the better it is. Compounding AND high rate of returns. One of the most effective ways to show the power of compounding is explained in this article (and thousand of clones): the first ten years of savings can be more powerful than the next four decades combined. If you manage to achieve a 7% return per year, every year. Unfortunately, what happens in reality is different. The chances of you buying a 100% stock ETF, with no country bias, and sticking with it during the first bear market you will face are very, very slim. If you start early, you will gamble your savings in meme stocks, crypto, NFTs, FX, day trading, or whatever is the strategy du jour. Get over it.

You are in such a dire situation that it won’t matter. If you have a relatively low salary and no prospect to materially improve it in the future, saving to travel and having a nice holiday with your family from time to time might be better than thinking about your retirement. If you decide to focus on the now instead of the distant future, I won’t blame you. I have an issue with those articles that imply “it only takes a saving strategy to become a millionaire”. No dude; you might arrive to have a million, but after 40 or more years that million is not anymore the million you had in your mind when you read the article. Inflation anyone?

Why it makes sense to start early

“It’s not the habit, it’s the learning”. Not sure who said it but they were right. You should learn personal finance and investing basic concepts as soon as you can, because they will have a big impact on your life (both on the positive, see compounding, and negative, see credit card costs, side). Saving is what allows you to “get your hands dirty” or “have skin in the game”; you can learn without having money to invest, you might just need a few $$$ to buy a book, but it is true that to keep your interest alive is better to have “the real experience”.

But please, do not mistake what I just wrote for the difference between paper trading and real trading. Saving (investing) and trading is two very different things. Yes, they both have an emotional component when you deal with real money, but on the saving side, emotions start to surface when you have saved a sizable pot; experiencing a 30% drawdown when you have a few thousand aside will not improve a bit the pain in your stomach (or your reaction) when the same happens and you have a million at stake. [in trading, acting on a stop-loss when you deal with real money is very different than with simulated one, almost irrespective of what is at stake]

Freedom and optionality. Small or large, a saving pot opens some doors that would have been otherwise closed. As with any other type of optionality, it comes with a cost: you know what you are renouncing today while you do not know what the future would bring. If, for example, you think you will want to buy an apartment sooner rather than later in life, starting to put something on the side might be the right decision, even if you are not 100% sure today that it will happen. Only you can assess the costs, the opportunities and the related probabilities of your objectives.

To not become a slave of your lifestyle. If you earn 4k/month but you spend only 2k/month, a 50% cut of your salary will not affect your life a bit (almost). If you spend everything, even going back to an “average” salary will feel like an absolute disaster. You probably worked&studied hard to achieve a high-salary position, so I get the urgency to enjoy it. But what if you get burnout at work? What if you realize you do not want that career anymore? Jeez, maybe I watched too many episodes of Industry lately eheh…but you get the point. You do not want to be forced into an unpleasant situation just to avoid something that might feel worse.

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