Why Do Household Savings Matter?

The decline in household savings has been well chronicled in both government statistics and the popular press.  According to the US Bureau of Economic Analysis, from 1959-2013, the monthly personal savings rate in the United States, as a percentage of disposable personal income, averaged 6.8%, reaching an all-time high of 14.6% in May 1975 and a record low of 0.8% in April 2005.  The most recent reading in December 2013 was 3.9%.  What these numbers don’t tell us, is why we should care.

Changes in the personal savings rate matter because our ability to maintain the high standard of living we have historically enjoyed will be diminished if we fail to save and plan properly.  Private savings provide the basis of future consumption for individuals and are critically important for growth in the entire economy.

While many economists have stressed that a number of flaws exist in the most widely used estimates of the US personal savings rates, they do not fully account for the overall decline that has occurred since the mid-1980s.  A number of theories have been advanced to explain the drop in savings:  Wealth Effect – this theory is fairly simple and implies that a rise in personal wealth lowers personal savings rates.  The bull market in stocks and bonds during much of the 1980s and 1990s created significant wealth for many American households; New Economy Effect – a theory rooted in the belief that recent technological advances and increases in labor productivity revise expectations of future incomes.  Americans believing in the promise of a better future may save less today; Financial Innovation – innovations in the credit markets have made it possible to increase purchasing power, facilitating an environment of increased consumption and reduced savings (one need only think of the exotic mortgages and relaxed credit standards that allowed buyers to increasingly take on more debt than was prudent); Social Security Programs and Macroeconomic Stability – this theory stresses that US households, seeing evidence that Social Security, Medicare, and other government transfer programs work, have increased their consumption levels, feeling that their own personal savings may not be needed; Demographics – an aging American population inevitably leads to a decline in the personal savings rate

While there is plausibility to each of these theories, they remain insufficient to explain the entire magnitude of the transformation of the US from a nation of savers to spendthrifts. But regardless of the reason, we wish to remind investors why it is so important to save:

1. Emergencies – Expect the unexpected.  It is important to set aside funds for the unknowns in life whether a sudden loss of income, expenses related to the maintenance of a home or vehicle, out of pocket medical expenses, etc.
2. Retirement – If you intend to retire someday, you will need savings and investments to take the place of the income you’ll no longer receive from employment.  The most important decision individuals can make about retirement is to take responsibility for funding it themselves.
3. Education – A college diploma has become a necessity for anyone seeking career opportunity, job security and increased earnings potential.  According to the US Department of Labor, by 2020, 75% of all US jobs will require a degree beyond high school, up from 62% today.  The chart at right details unemployment rates by educational attainment.
4. Future Purchases – Your negotiating power goes a lot farther when you have a significant down payment set aside for a large purchase such as a car or home.
5. Financial Independence – A well thought out savings and investment plan gives you peace of mind and affords you opportunities that can only be attained with financial preparedness.

So keep saving!  And update your financial plan as it will help provide you with the necessary roadmap to achieve your personal goals.  The customized financial plans we develop at Madison reinforce the timeless concepts of goal setting, thrift and saving.

“Anything we can do to raise personal savings is very much in the interests of this country.”

                                                                                                           Alan Greenspan