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| The Basics | |||||||||||||||
| Is saving nothing a big deal? | |||||||||||||||
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Americans bled savings accounts and home equity to spend more than they earned in 2005. Some analysts say thats not necessarily as bad as it sounds. By Bankrate.com It's a bit soon to tell if American consumers made -- and are keeping -- New Year's resolutions to save more money this year. But they should. The number-crunching folks at the U.S. Commerce Department's Bureau of Economic Analysis dished out some discouraging news recently, saying that Americans spent more than they earned in 2005 -- a negative savings rate of 0.5% for the year. That's the first time that's happened since the Great Depression. A negative savings rate can't be good, but is it as dire as it sounds? Why are people seemingly so carefree about spending?
If your savings rate is negative, it doesn't necessarily mean that you don't have any savings. It means you're spending more than you earn, so you're dipping into your savings or you're borrowing to pay for purchases. Our saving habits have been doing a gradual slide since May 1985, when we saved 11.1% of our disposable income. Here's a chart illustrating our choppy savings habits over the last years.  People may engage in excessive spending for a number of reasons. It may be that they're not concerned about losing their jobs. Perhaps the rebounding stock market has boosted their portfolios, or they may be in line for hefty inheritances, or they may be assuming that the newly bloated value of their homes caused by the real estate boom will last forever. In any case, the question remains: How serious a problem is the negative savings rate? We asked three experts to give us their view of the savings/spending situation and to give us some insight into the economics and psychology involved. Are you spending wealth or income? Joel Naroff, president and chief economist of Naroff Economics Advisors in Holland, Pa., addresses the question: Is negative savings a problem? More from Bankrate.com and MSN Money
"The savings rate is the difference between income and spending. It's a residual; it's what's left over. It's also a flow. On a monthly basis it looks at how much people earn from all income sources versus how much they spend. "The problem is I make a killing in the stock market and I sell some shares. The money I get from selling isn't income, it's wealth. I didn't earn it, I got it through my investments. If I spend that wealth, instead of having $10,000 in stock, I have $5,000. That means I have spent some of my wealth, not income. It's wealth I'm drawing down. It goes into spending but not income. That's a key factor. "Economists call it the wealth effect. As my wealth grows, I tend to spend more. So to some extent, the savings rate is a number that you have to be careful about when you use the word 'negative.' It is a negative -- I spend every penny and I draw down on some of my wealth. But I created some of that wealth and it's not necessarily good, bad or indifferent that I spend it. It's tied to how I view the future. If I make a half-million dollars selling my house and I take out $50,000, big deal. "To some extent, we're spending way beyond our means. We're drawing down on wealth that has come from equities or, more importantly, our homes. Economists worry because we've gone through an environment where housing prices have soared, and we've spent a lot of the wealth that was generated. "The probability that over the next three years, we'll see that same increase in property values is pretty low, and there's the possibility that prices will fall. What that says to economists is that the probability that we'll draw that kind of money from equity again is small. If we spend a lot of the wealth and we don't have that money going forward, consumer spending slows and the economy slows." Inheritances to the rescue John Merrill, investment manager and founder of Tanglewood Capital Management in Houston, addresses the question: Is negative savings a problem? "If you look at financial history, most individuals focus on their income statement -- how many dollars are coming in and how many are going out. Institutions look at their income statement and their balance sheet. Banks looks to see how much leverage they can tolerate, because that's how they can expand their earnings. "Individuals, because of asset inflation during the past decade in everything from stocks to real estate, are also now looking at their balance sheet and not just the income statement. They're judging their overall financial health. Am I growing in value? People are looking at their finances in a multifaceted way. Brokerage accounts and software such as Quicken have made people much more aware of their balance sheet today than they were a decade ago. "This provides the opportunity to see if the balance sheet is growing. Are assets growing faster than liabilities? Then I'm worth more at the end of the year than at the beginning of the year. I'm making a net improvement. So what if I increase my leverage? I'm still better off than at the beginning of the year. "But I think there are two dangers. The first is that home prices flatten or drop. Then the balance sheet doesn't keep growing for a big share of the American populace and then they don't have that to fall back on. "The second danger is, it's one thing to look at a balance sheet and say it's growing, but it's another to pay bills each week. If interest expense keeps growing, it squeezes out what you can pay for other items. As a nation it crowds out other spending. You have less disposable income. "Overall, I think the baby boomer generation is in great financial health. Divide it into a top half and a bottom half. The top half is significantly better off than the bottom half. They can't fall back on an increasing balance sheet, so they're still more controlled by seat-of-the-pants dollars in and dollars out. "But the inheritance factor figures in. Some people in the bottom half will inherit, so they're not in as bad a situation as you might think. I have over 300 clients in the baby boomer generation, and the generation that preceded them, and I see a tremendous desire by the older generations to help the younger generation. They're not just waiting to hand over money as an inheritance; they're buying them new cars and homes." Time to go back to basics Tony Proctor, certified financial planner and president, Proctor Financial, in Wellesley, Mass., addresses the question: Is negative savings a problem? "There's going to be a serious price to pay when housing stops appreciating at the rate it's been appreciating. It's not that people aren't saving a negative 0.5%; they're saving, but they're overspending. They might be putting money into their 401(k) and their IRA but they're spending all their other income plus they're taking equity out of their home. That would work OK if housing keeps appreciating, but that's not likely. They're going to have to substantially reduce their lifestyles or they'll have to stop whatever saving they're doing. "There are people who are really doing the savings -- maxing out retirement plans at work. I'm not concerned about them. Then there's a whole other group that's putting small amounts into their retirement plans, and they feel that's enough. With the amount of spending they're doing they need to put much, much more into their retirement plan so that when they retire they can maintain that lifestyle. They're causing the negative savings rate. "A lot of people believe they'll work until they're 70 or 75. They think they don't need to max their retirement plan because they'll work for a very long time and they're in good health. Then they get to 60 and realize that they're getting tired and they think they'll retire at 62 or 65 or 66. The reality is that when they get into their later years, their bodies have changed their minds for them. "When you're 45 you're in the prime of your career and you're exactly the type of employee they want. By the time you're 60, you're lucky if you're not laid off. If you haven't taken a serious stance toward retirement savings, you're in trouble. "Go back to basics. Save 10% of gross income every single year. For some reason we've gotten away from feeling that saving is our responsibility. We have to save for ourselves. An emergency fund is not truly savings, it's deferral of spending because it's something we expect to spend. "I see a lot of people who have sacrificed everything for their children. The whole baby boomer generation has a tendency to overspend on their children. They put their kids through college and now they have a couple hundred thousand on their home-equity line that wasn't there before college. They don't want their children to be burdened with debt to start their life, but it's ironic because they're burdening themselves with debt." By Laura Bruce, Bankrate.com | |||||||||||||||
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