It’s fun to search financial news from the mid ‘00s – from 2005, 2006. Before the Big Crash. You’ll find articles like this one, which suggests that the decline in the U.S. personal savings rate (savings divided by disposable income) to zero (as of June 2005) may not really matter because the official report “excludes realized and unrealized capital gains from stocks, homes and other investments.” I’m sure the words “unrealized” and “homes” jumped out at you. The article goes on to say that “These assets, despite some ups and downs, have generally been appreciating in recent years.” Well, at least they had been appreciating. Not so much these days.
How America’s Personal Savings Rate Compares
For many decades, the personal savings rate hovered around ten percent. It’s higher in Europe and much higher in China, which has the highest in the world. America’s personal savings rate did indeed approach zero in 2005, and has now grown back to about six percent. That’s a good thing, right? Americans are tightening their belts and saving for a rainy day.
But many economists are actually worried that the savings rate is too high now. In order for the economic recovery to continue, they argue, Americans have to do what they do best: spend. Instead, it appears we’ve finally been spooked into saving a little. In fact, much of these savings may not even be of the squirrel-away-part-of-your-paycheck variety. Banks, in spite of the bailout, continue to be reluctant to lend as we emerge from the Great Recession. That means less credit for consumers, which means less money to spend, which automatically bumps up the “savings rate” whether we’re consciously being frugal or not.
What is the Ideal Personal Savings Rate?
With conflicting advice about whether it is better for the economy to spend or save, what is an individual to do? The fact is, you can’t responsibly help your country dig its way out of a recession if you don’t have savings to spend. During the Great Depression, the savings rate neared zero rather than spiking the way it is now because that generation of Americans did have savings – and they dipped into them out of necessity when times became tough. So the best advice is to be ready for everything and anything: for the unexpected loss of a job, for that startup you always wanted to launch, for retirement, for another global financial crisis. But you’ll need to know how much to save, right?
It may not come as a surprise that Elizabeth Warren, a Harvard professor and original architect of the Consumer Financial Protection Bureau, has a suggestion. She co-wrote a book called All Your Worth: The Ultimate Lifetime Money Plan which proposes the Balanced Money Formula: spend no more than 50% of your disposable income on your needs, spend 30% on your wants, and save 20%. Now, we’ll leave what constitutes a want or a need up to you – as well as how you save, be it through money market accounts, CDs, stocks, bonds, IRAs or even (gasp) real estate. Just make sure that your investments are sufficiently liquid so that you can turn them into cash when necessary.
While America’s personal savings rate might not reach that of China’s any time soon, at least our generation can learn from considering the headlines of the recent past in the current context. When people begin thinking “it’s different this time”, and things seem too good to be true, well, then they probably are.