{"id":251877,"date":"2026-07-29T13:02:04","date_gmt":"2026-07-29T17:02:04","guid":{"rendered":"https:\/\/ibkrcampus.com\/campus\/?p=251877"},"modified":"2026-07-29T16:58:28","modified_gmt":"2026-07-29T20:58:28","slug":"why-we-borrow-save-and-invest-the-psychology-of-consumption-smoothing-and-building-wealth-for-life","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/why-we-borrow-save-and-invest-the-psychology-of-consumption-smoothing-and-building-wealth-for-life\/","title":{"rendered":"Why We Borrow, Save, and Invest: The Psychology of Consumption Smoothing and Building Wealth for Life"},"content":{"rendered":"\n<p class=\"wp-block-paragraph\"><\/p>\n\n\n\n<iframe title=\"Why We Borrow, Save, and Invest: The Psychology of Consumption Smoothing and Building Wealth for Life\" allowtransparency=\"true\" height=\"150\" width=\"100%\" style=\"border: none; min-width: min(100%, 430px);height:150px;\" scrolling=\"no\" data-name=\"pb-iframe-player\" src=\"https:\/\/www.podbean.com\/player-v2\/?i=gqw53-1b2226a-pb&#038;from=pb6admin&#038;share=1&#038;download=1&#038;rtl=0&#038;fonts=Arial&#038;skin=1b1b1b&#038;font-color=auto&#038;logo_link=episode_page&#038;btn-skin=c73a3a\" loading=\"lazy\"><\/iframe>\n\n\n\n<h2 id=\"h-summary\" class=\"wp-block-heading\">Summary<\/h2>\n\n\n\n<p class=\"wp-block-paragraph\"><em>The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made<\/em>.<\/p>\n\n\n\n<div class=\"wp-block-buttons is-layout-flex wp-block-buttons-is-layout-flex\">\n<div class=\"wp-block-button has-custom-width wp-block-button__width-50\"><a class=\"wp-block-button__link wp-element-button\" href=\"https:\/\/ndcdyn.interactivebrokers.com\/mkt\/?src=podCOSAcc&amp;url=%2FUniversal%2FApplication\">Open Account<\/a><\/div>\n<\/div>\n\n\n\n<h3 id=\"h-drew-tunstall\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Hello, everybody. I&#8217;m Drew. Welcome back to the Cents of Security podcast. Today we&#8217;ll be talking about one of the most important theories underpinning our current understanding of behavioral economics: consumption smoothing.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Consumption smoothing is an economic concept which states people will choose to live in a consistent state of consumption and comfort throughout their life, even if their income is expected to rise over time. To help guide us through this topic today, I&#8217;m joined by James Yendrey of InvestMentor. James, how are you?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">I&#8217;m doing well, Drew. How are you? Good to meet you!<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-0\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Doing great. Nice to meet you, too. Could you please tell us more about how consumption smoothing works?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-0\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Sure. At its core, consumption smoothing is like you stated, the idea that people are attempting to maintain a relatively stable standard of living even in their low-income years. Most of us don&#8217;t really earn the same amount every year of our lives. We might earn very little as students and l- a lot more when we get to our mid-careers, and then back down to less again in retirement.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">So, if people want to only spend what they earn each year, their lifestyles would swing dramatically over time and a- as you enter these different phases of life. So instead, they try to spread the resources across their entire lifetime. They borrow when they&#8217;re young, they, they save in their peak earning years and they even invest for later in their life, so<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-1\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Awesome. Why has consumption smoothing become so important to our understanding of modern economics, and how does it help us explain how people make financial decisions?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-1\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">It&#8217;s become more foundational over the past, I&#8217;d say more recent decades. And I would say this probably due&#8211; because prior to these ideas becoming what we&#8217;ll call mainstream there was a tendency to assume that people simply just spent with what their basic income was. What this theory suggests is something a little, a little deeper than that, where people start making decisions earlier on in life looking forward.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">And so, they&#8217;re basing what their current acquisitions are over their lifetime earnings, and it helps us explain reasons for, justifications for y- people going into debt for universities. Think of a medical&#8230; a doctor going to medical school, and why he may take and absorb an amount of debt and still maintain a more reasonable lifestyle while living, whereas a retiree may continue to spend despite no- not necessarily earning in their later years of life.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">So, both are making decisions based off of their lifetime resources allocation, not necessarily income alone.<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-2\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">And so we&#8217;re seeing this in the data and across the lives of normal people and outside of the realm of just theory?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-2\" class=\"wp-block-heading\">James Yendrey <\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Yeah, we definitely are, and you can see it a lot whenever it comes to mortgages, for instance. Mortgages and student loans are actually going to be very very key drivers for this particular topic specifically. So, they&#8217;re core elements for it.<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-3\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">What are the some of the biggest assumptions behind consumption smoothing?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-3\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Lot of assumptions. It&#8217;s quite demanding, right? So, a lot of economic topics, they take more of a an EMH approach where it&#8217;s like an effective market hypothesis. But in, in practice it&#8217;s a bit different. So, people need access to credit when they&#8217;re young and the discipline to save when they&#8217;re a bit older.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">They&#8217;ll need some of the ability to forecast future income, financial markets, the function of reasonability as well. So, in reality, when you start to break it down, those assumptions start to fade a bit. Someone living paycheck to paycheck might not necessarily know their income will rise in the future but still be unable to borrow today.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">In practice it becomes a little bit more complex than just the EMH hypothesis kind of dictates.<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-4\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">So, for people of different income groups, even if they do expect their income to rise as they get older do we see that consumption smoothing is practiced by someone who maybe thinks that their maximum income is going to be $100,000? Do we see them making decisions in a similar way to someone whose maximum income would be a million?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-4\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">I would say that the baseline logic is still the same. The ability to smooth over decades is the core concept is going to remain the same. But it does differ whenever you start thinking of somebody who&#8217;s making, say, $50,000 versus $500,000 because you have that 10X multiplier difference.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">So, individuals, they might try to spread lifetime resources across that period of, that specific period of time based off of whether their wage is going to go. But again, you&#8217;re not necessarily going to realize when you&#8217;re going to get that raise.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">So, the difference between the two would be a higher income individual would typically have a lot more flexibility than a normal individual. We&#8217;ll call it somebody who&#8217;s earning, $ 75,000 to $100,000 a year. Someone earning in the $50,000 might spend their income on necessities and food and housing rather than having disposable income to invest for their future self.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">And so that kind of hinders what that might look like for that individual.<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-5\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">So even without factoring in things like inflation, a dollar now is going to be a lot more valuable for someone than a dollar in the future. How do economists try to quantify the difference between a dollar now and a dollar in, say, 10 years?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-5\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Well, I tend to use the TVM approach, time value of money approach, whenever it comes to this. When you think of it as deployable capital inside of what would be a person&#8217;s allocated budget, think of money being the utility of it, right? The first few dollars you earn during the month are going to be significantly more valuable than that in the later part of the month because you have things like rent and mortgage, and your bills usually hit towards the first part of the month, whereas the second part of the month you have more discretionary, more savings kind of happening towards that back half of the month.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">That&#8217;s how it would, that&#8217;s how it would look within this concept. But if you take it a step further and you deploy that TVM approach to it, and you think of it as far as investing is concerned, say you&#8217;re in your early 20s and you are only about&#8211; you are only making about 75 to 100,000 a year, investing where you can in your early 20s, you have four decades worth of compound growth happening.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Whereas if you would&#8217;ve just stuffed it in a mattress or in a checking account, it would erode due to factors like inflation<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-6\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Okay. So, if for young people they have an extra incentive to invest early and accrue compound interest, that seems to go against the principles of consumption smoothing, where we&#8217;d expect them to borrow more early on. How can we reconcile these two experiences?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-6\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">They&#8217;re actually very consistent with one another. So, consumption smoothing doesn&#8217;t say that you should consume the same amount each year. It says that you should allocate resources across time in a way that supports a stable standard of living. So, investing early can be one of the most effective ways to do it.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Like a young worker can contribute to his retirement and get those four decades that we just talked about and basically pay dividends to your future self now and later.<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-7\" class=\"wp-block-heading\">Drew Tunstall <\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Consumption smoothing assumes people make fairly rational financial decisions. Where do behavioral biases tend to cause people to deviate away from the theory?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-7\" class=\"wp-block-heading\">James Yendrey <\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">I would say recency bias. Recency bias is, would be a huge one. Placing too much weight on more immediate rewards and too little weight on future consequences, right? You can make all the money in the world in your 30s and 40s at your peak earnings, but if you don&#8217;t set any aside or allocate it appropriately to your future, you&#8217;re, you not setting yourself up for success in your later years.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">That&#8217;s why a lot of people save less than they intend to. They carry expensive credit card balances or struggle to prepare for retirement. There&#8217;s also overconfidence. Some people assume future raises, bonuses, careers, opportunity will arrive with greater certainty than they actually will.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">You&#8217;re really hoping for that, that Christmas bonus to be to carry you over the edge, but if it is a fraction of what it what you assumed it would be, it kind of stings and it hurts the budget for the future. So, &nbsp;you have multiple layers on that one<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-8\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Okay. So, building on irrationality and recency bias, in recent months and even years, we&#8217;ve seen that the consumer confidence has fallen out of line with general economic performance in America, and we haven&#8217;t seen consumption go down even as what we would define as expected future income has gone down.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Do we have anything that can explain why this is happening in the American public right now?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-8\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">That&#8217;s a good question. There are a few possibilities for this one. One of which is that, expressing concern about the economy in general while remaining relatively confident about their own finances, so taking a more subjective approach rather than zooming out and having a more macro view.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">You have confidence surveys that often capture sentiment towards kind of headlines, geopolitical risks, and broader economic conditions rather than personal circumstances, right? So taking that subjective approach will allow an individual to be potentially more confident in their earning capabilities than, than what headwinds they may face in the actual marketplace.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Another possibility could be that households simply haven&#8217;t changed their view of long-term income very much. Consumption smoothing is primarily about lifetime resource allocations, right? So, worrying about the current news cycles may not necessarily be sufficient to alter any decisions meaningfully if a person still feels secure in their job and the expected future income that they will earn.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Then you also have to take in the fact that there&#8217;s also inertia out there. People are s- people&#8217;s spending habits don&#8217;t really change overnight. Mortgages, rents, childcare even if you drove down the subscription cost, like sometimes when you try to find margin in budgets, the first thing that, that should go is subscription costs.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">If you&#8217;re penny-pinching or you&#8217;re trying to save money, maybe get rid of Netflix maybe get rid of Hulu because these are starting&#8230; these are subscriptions that kind of add. But it&#8217;s changing those habits, though they may seem easy surface level are a lot harder for individuals to actually do in practice<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-9\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Awesome. Thank you so much. If there was one thing for the audience to take away from consumption smoothing, what would it be?<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-9\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">I would say the biggest lesson to think about is to take finances as a lifelong process rather than a series of individual good months versus bad months, right? Most of our financial mistakes are going to happen and if we focus too much on them, it&#8217;s not really going to do us any good.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Consumption smoothing is really about trying to find balance in what you&#8217;re doing today to better yourself for tomorrow. And it reminds us that today&#8217;s decisions affect the opportunities that w- that we have allocated towards us to say, tomorrow. But, if you manage your resources across your lifetime and take of it, think of it in human years you&#8217;re really trying to build out a life that&#8217;s sustainable, that you can enjoy, that&#8217;s resilient at every stage, and not just when you&#8217;re at peak earnings.<\/p>\n\n\n\n<h3 id=\"h-drew-tunstall-10\" class=\"wp-block-heading\">Drew Tunstall<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Awesome. Thank you so much. For our audience, this has been Cents of Security with me, Drew Tunstall, and James Yendrey, and and we&#8217;ll catch you later.<\/p>\n\n\n\n<h3 id=\"h-james-yendrey-10\" class=\"wp-block-heading\">James Yendrey<\/h3>\n\n\n\n<p class=\"wp-block-paragraph\">Bye, guys.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Why do people take on student loans, buy homes, and invest decades before retirement? James Yendrey of InvestMentorSM breaks down consumption smoothing\u2014the economic theory that explains how people spread resources across their lifetime\u2014and explores how behavioral biases, debt, investing, and future expectations shape our financial decisions.<\/p>\n","protected":false},"author":1351,"featured_media":251884,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[15591,13857,3],"tags":[],"contributors-categories":[20768],"class_list":["post-251877","post","type-post","status-publish","format-standard","has-post-thumbnail","category-cents-of-security","category-podcasts","category-traders-insight","contributors-categories-ibkr-investmentor"],"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin 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