Is saving really saving?
I’ve been watching the U.S. consumer savings rate climb. It’s been heartening to witness the ascent past 5% on its way to perhaps 7%. Any way you look at it, this is a welcome—if not critical—change in our financial/economic behavior.
I started digging into how this rate is computed and asked a few of our resident economists for some explanation. As a result, I don’t feel quite as good about the savings rate as I did, but I understand the basis for it much better.
From a macroeconomic perspective, savings comprise after-tax disposable income minus consumer spending. For example, if the ratio of consumer spending to personal income fell from 98% to 95%, the savings rate in an economic sense would increase from 2% to 5%. Economists look to the sources of income—how much income is in excess of spending—not the uses of it.
In essence, “savings” can only go three places: toward paying off debt (deleveraging), for investment, or into cash reserves. So when you hear about savings rates climbing, it doesn’t necessarily mean consumers have additional liquid assets in their bank accounts or that they’re investing more. Increased savings could be primarily used to reduce leverage—something that raises one’s overall net worth but doesn’t increase liquid assets. It’s a form of savings, to be sure, but not quite in the way consumers typically understand it.
There is evidence that consumer debt ratios are coming down. The ratio of homeowner household debt service payments and financial obligations to disposable personal income (“consumer FOR,” or financial obligations ratio) dropped from 17.58 in the first quarter of 2008 to 16.36 in third-quarter 2009. Just 20 years ago, the ratio was 13.40.
Once excessive debt levels have been dealt with, let’s hope consumers actually increase what we all think of as savings and don’t slip back into their old habits.
You are too easily disappointed.
Reduced debt is as good as if not better than what you used to think of as saving.
Go back and listen some more to your economists.
My wife and I fit that trend… Over the past year we had been aggressively saving cash in our money market account to build a reserve if one of us became unemployed. With layoff fears diminishing and money market returns virtually nil, we decided to pay off her student loan which was $40K at 6.5%.
In this market, a “guaranteed” 6.5%-after-tax saving is the best return-for-risk ratio we can find.
Instead of leaving money in a bank account earning nothing we paid off our new car instead of paying intrest.
My wife and I completed our family rainy day fund last month. It took us two years to do so and now we are focused on debt reduction. After we eliminate the debt, we’ll focus on investing. We save to create a better life — not to simply accumulate money.
Our rainy day fund allows us to deal with life’s unpleasant moments and me to walk away from a job I dislike without the worry of borrowing money at usurious rates or making draconian cuts to our lifestyle. Debt reduction lowers our recurring monthly expenses which produces more career flexibility and reduces the eventual size of our retirement nest egg. In turn, a smaller nest egg means our investments don’t have to be as aggressive — so we both sleep better at night without worrying about how the market’s daily movements will impact achieving our lifetime goals. Although our family’s savings come at the expense of consumerism, we truly are much happier saving for our freedom.
Although our 20% savings rate is no longer growing our bank accounts–our family future is even brighter!
I think of this as the “wealth effect” (http://en.wikipedia.org/wiki/Wealth_effect) in reverse. When one feels “poorer” (ie, perceived wealth) one reduces nonessential spending likely in proportion to your sense of gloom. If the economy improves, and home prices stabilize/rise we likely will see the savings rate decline, but hopefully stay at a more prudent rate than before the recession. However, I do think that on the down side, the reduced wealth is more real than the upside “gains” based on, say, home value as much wealth has been recently.
Toward the first person to comment, it’s true that for a person already in debt paying that off can be as good or better than saving. However I believe that article is referring more toward the financial lifestyle of Americans and when looking at that, being forced to pay off debt accumulated through poor decision making is not an improvement. An increase in savings and investing on the other hand, would be a step toward a more responsible use of money.
The timing of savings never seems to be right. It always seems to be too low when the economy is srong, as people spend more than they make (disavings) leading to fears of inflation. And savings is too high during recessions when the country needs consumers to spend more to stimulate the ecomony. Either way, savings was always a source of funds for banks to lend, which was a good thing if banks are willing to lend. In today’s environment, the increasing level of savings is good for for those of us who are paying down our debt, but not so good for those of us who are out of work and need consumers to start spending again to create jobs.
It is good to hear that people are paying down debt and/or saving. I’m curious what will happen when the economy stabilizes, people are able to find good jobs and the housing market begins to rebound. I suspect that a lot of those “savings” will disappear. We should just hope that folks will use more descretion about taking on more debt than they can afford. Lenders should also be held to account for loaning money according to what people can afford to repay.
My only “saving” is the money in my wallet. Everything else is spent, either on goods or things that will make money (aka investing).
I do remember a comment on the US Government’s idea of savings. The rate was going down because they did not consider a new area, I think 401(k), to be “saving”.
I am a very wise and prudent person. Everyone else is foolish with their money.
It is indeed good to see people saving, but it probably won’t last forever. Saving is like dieting. After a while, it’s hard to keep on track, especially when things need repair or replacement.
I heard this in one of my econonics classes many years ago:
That which is not consumed is saved.
I also head this:
It is a fool’s errand to borrow money to but a depreciating asset.
Good comments. I appreciate the article as it illustrates that what the government give us a reports are not based on what we think they are. Inflation rate is a perfect example. Just remember that you only have what you own. Cars are not a investment. They are a liability!!!! Homes are not an investment. Look at your return over the last 20ryrs. They like cars are just a standard of liveing. When we get our standared of living to reflect our income we will get a grasp on what we should be doing. Look at the recent finical crisis. Nothing more than people buying what they can’t afford. Why would anyone think that with an income of 50,000 they can afford a 200,000 dollar home? Sorry about the ranting. Very good article.
Why should we save money? Inflation is >2%, and I have to invest increasingly risky assets to just stay try to stay even with it (money mkt rate = .2%). Why are 401K plans tax deferred, but not saving accounts? Why is interest income taxable?
Over the past year we had been aggressively saving cash in our money market account to build a reserve if one of us became unemployed,When we get our standared of living to reflect our income we will get a grasp on what we should be doing.
Good comments. I appreciate the article
Too many people have become used to buying whatever they see for sale regardless of whether they need it or not. Acquisition of material goods appears to be our downfall. If all of us would buy only what we need in our lives and refuse to buy what we want and ot really NEED, we would be much better off financially…………not in debt.
Interest paid the the devil unless it is advantaged and then it is only mini-evil (grin). As my wife and I passed paying off all unsecured debit (credit cards,etc.) and then paid off all three of our cars I began to realize how much interest really cost us. Look at how much you are paying for a car payment and how much of that goes toward principle and we woke up quickly. The magic thing is, the more you pay off, those payments can be applied to other debits. It is like a positive snowball and now we are down to just the house we owe money on. We are saving aggressively, but are still traveling and living our life. The house will not be paid off until we have the entire payoff in cash. Having more equity in something that can be foreclosed in bad times makes no sense. Sure there is the cost of interest until then but that is at least tax advantaged a bit and we are on a seriously aggressive path (think 3.5 years). It is too hard to part with that kind of cash until I know it will pay off the entire house. At that point we will be 42 and 41 years old with no debit and two incomes. I do not enjoy feeling beholden to anyone or feeling in debit. To be honest I know it is just psychology, but I feel free when I do not owe. This is a far cry from where I was when I was 19-26 years old. I am only saddened that the cash we have is not worth much as banks can get money from the fed. for essentially free and I cannot get nearly anything for mine without serious risk.
We save for emergencies, pay down debt, invest for education, and invest for our golden years…pretty much what advisers routinely recommend. Then for the last ten years the financial markets have been a roller coaster ride. Millions of our working population now have no pensions and are on our own to provide for our future financial needs. We should abolish the Fed for they create a money supply that is backed by thin air….this causes our inflation…more fiat dollars sent to banks and more debt created in the market. We should have our money backed by gold, silver, or some commodity which would give our money value. Also, after our financial crisis was exposed by the failure of Wall St, mortgage lenders, our Congress, and gullible home buyers we now are paying the price with high unemployment. We wonder what’s next….insider trading and sharing of market info before retail investors have access, thus making stocks overpriced and then another bust? Yes, we need to save, pay down debt, and invest, but can we trust or financial markets to play fair? If we are to succeed, our goverment and financial markets should make sure that they don’t violate our trust but instill confidence.