By Ryan Dolan
Your savings rate (how much you save in relation to your pretax income) is one of the simplest and best predictors of your financial future. A high savings rate embodies a strong financial mindset: humility, delayed gratification, a focus on prioritizing economic growth and security over lifestyle. The longer I work with people and their money, the more I have come to believe in the power and simple elegance of this number and what it represents.
At the same time, I also strongly believe that the capacity to save (or not save) is largely innate. While it can be improved at the margin, it is a largely unwinnable battle to turn a non-saver into a strong saver. The ability to save, in other words, is overwhelmingly nature and not nurture. A landmark study looked at the savings behavior over time of fraternal twins and found that “individuals are born with a persistent genetic predisposition to a savings behavior.” While the authors found that parenting influence had some impact on young adults, they found that spending gravitated back to genetic factors by mid-life. My own experience as an advisor echoes this.
Competence in any professional field involves knowing what you can do, and maybe more importantly, what you can’t. Knowing how crucial savings is to driving good financial outcomes for clients, while simultaneously understanding how limited my capacity to effect large change in this area, is professionally humbling. But it’s unavoidably true. As Charlie Munger once said: ”If you don’t know how to save, I can’t help you.”
Munger’s partner Warren Buffett observed a trend about companies in the same competitive industry, one with a history of the highest profit margins in the industry, the other with the worst. Typically, the high profit margin companies, in spite of already being leaner and more efficient than the competition, are almost always able to maintain and even extend these margins over time. They are always finding ways to cut costs. These companies present a tailwind of pleasant surprises to their owners. Conversely, the competitor with the worst profit margins, in spite of the highest costs and imost nefficiencies, seems to face a litany of unexpected cost overruns and financial problems-headwinds abound.
This matches my experience with clients. There is a far higher likelihood of driving a client’s 20% savings rate to 30%, than it is taking another from 0% to 10%. Perhaps it was due to professional overconfidence or maybe my inexperience, but I used to think I could reform chronic undersavers. I believe my motivation was sound-nothing can be more impactful than pivoting someone from not saving to saving. If achieved, it could literally change their lives. In almost every case, however, this was largely a mirage, in spite of the best-intentions of everyone involved.
Take a couple I’ve worked with for a few years, the Danahers (not their real names). In their mid 40s, he is a technology executive and she a homemaker. His income had grown considerably over the prior few years, rising from roughly $500,000 to $1.2 million. So far so good. But as I constructed their initial balance sheet and dug into their cash flow trends, alarm bells started going off almost immediately. Their net worth was very low relative to their age and income history. Worse (and relatedly) they didn’t seem to be saving much of any money, in spite of ramping income.
The couple owned two pricey homes, their primary home in the Bay Area suburbs and a vacation home in Lake Tahoe purchased the prior year. The homes dominated their balance sheet: their assets were overwhelmingly concentrated in this low return, illiquid, negative cash flow asset; and the mortgages led to a very high debt-to-net worth ratio. The homes were responsible for a huge cash flow headwind, with high fixed and variable costs.
For a couple who saw their income more than double in the prior few years, I would expect to see a minimum savings rate of 20% . Looking at the prior year, when income was close to $1 million, it appeared they were burning cash. I almost didn’t believe the data-and yet the numbers were accurate. The culprit: the new home and relentless lifestyle creep.
I took them on as clients, with some reservations. I knew from experience that this would be a challenge, but I liked them and believed marked improvement was possible. The couple was intelligent, and knew they needed to make big changes. My goal in year one of the relationship was, I thought, modest: move to cash flow breakeven in the first six months and target a 5% savings rate in the second. Given the husband’s strong income projections for that year, and the obvious fat in their spending, I thought it a low bar.
It didn’t happen.
We did get to cash flow breakeven, but it took nearly 9 months. I was dismayed at how out of control and unpredictable their spending was. Now, a total of 18 months into the relationship, they are finally saving-about 5%-but it has been a titanic struggle, and well short of what I thought achievable by now.
While the progress we’ve made is meaningful, I’ve found the experience deflating. I figured if I could find the right words, or clearly define how change would benefit their family (and stasis would potentially harm them), and yet progress has been halting. I can see how this one factor is creating stress and tension in the couple individually and as a couple. They seem completely stuck on the so-called Hedonic Treadmill, were income increases, but spending increases even faster. They are running faster, but not really getting anywhere. It’s exhausting.
Worse, lack of savings leads to other problems. The couple should sell the vacation home to right size their spending, but they are banking on being bailed out by continued home price appreciation. I cautioned that a continuation of the strong returns of the last decade are unlikely to repeat in the next. There were worrying financial implications if they were wrong. It’s also been a battle getting them to have a more conservative investment framework. Poor savers almost always take a lottery ticket approach to investing, looking for homeruns to bail out their inability to save. It almost inevitably compounds the problem.
Like the low profit margin company Buffett referred to, the Danahers are fighting a relentless battle. We will make solid progress for a few months, and then some new, unexpected headwind rises up. In 2022, their spending is being impacted by high inflation-pushing their savings rate back to zero. Working with non-savers often feels like 3 steps forward, and 2 and a half staggering steps back.
Contrast this with another client couple of the same age. The Tuttle’s (also not their actual name) have been working with me for over a decade. At that time, they were in their mid-30s, owned a home, and had a history of disciplined saving. Working together, as their income has risen, and in spite of having three kids in the interim, their savings rate has continued to improve. Their high net worth, coupled with lots of cash in the bank and sizable investment assets are testament to that. Their biggest “problem” is the capable stewardship of their savings and investments.
The Tuttle’s have been a joy to work with. They are humble, accountable and their financial life provides them with security and optionality. They view their resources primarily as security and optionality for them and those they love-not as things. I will not quit on the Danaher’s and am committed to fighting in the trenches with them, but it’s not something I would do again.
When meeting with prospective clients today, one of the first things I look for is an ingrained savings history. If it’s there, and they are a fit, I’m confident I can help drive it higher and build a long term path to independence and financial security. If it’s not, I will turn the engagement down. In spite of how much help someone needs, how smart and capable they are, no matter how bright their current and future prospects-I find that it’s simply too hard, and my capacity to change the situation too limited to work with them.
Are you a saver or not? If you are-congratulations. You likely have a sound financial future foundation which can be optimized and enhanced with the right advisor. If not-I’m sorry. Even the best advisor with the most honorable of intentions is likely not enough.
Sad, but unfortunately, very true.
Dolan Partners works with professionals and business owners primarily in the real estate and lending, technology and executive search industries.
We work with clients who are at least 40 year old, have at least $750,000 in investment assets and are solid savers.
If you’d like to learn more, schedule a 20 minute introductory call.