Americans Can’t Save Money!
Posted in Money by George
A recent study came out that said the average American savings rate in 2005 was negative. Yup, that’s right, on average, people came out of 2005 with less money than they came in with. The last time the savings rate was negative was during the Great Depression. Nearly 80 years later, our savings rate is -0.7%. In the 70s and early 80s, the savings rate was 10% of disposable income. That’s a pretty healthy number. It has gradually declined since.
Why is this? Did the economy crash? No… things have been fine. The stock market was up, growth was normal, and everything was pretty much fine.
Some argue that the reason the savings rate is so low is because people are using the wrong numbers to calculate savings. Even so, they’re still using the same numbers today as they did in the 70s. If these numbers are wrong, it still shows a dramatic decline in SOMETHING that we used to call savings. I don’t think we can play a numbers game here and claim that we’re saving an adequate amount no matter which figures you look at.
I personally believe the savings rate is way too low. People really need to be concerned about how much money they are saving, because who knows when the next big emergency will strike and people will have to dip into savings?
I feel like the value of saving is not emphasized nearly enough. I think a concept like this should be drilled into the heads of youngsters in elementary, middle, and high school. Concepts like compound interest and investing are really interesting if people are taught about them at a young age. Later in life it just becomes another annoyance that you are supposed to do. I’m very glad that my parents talked to me about saving my money at a young age. I started an IRA last summer, at age 20, and I’m very glad I did it. The only thing I wish is that I had started it earlier.
I could go on and on about how I know tons of people my age and only slightly older with credit card debt, and who don’t mind carrying balances on their credit cards, etcetera. But I’m going to stop typing about this now, and just leave a list at the bottom of smart ways to plan for the future.
George’s Financial Tips
- Don’t ever carry a balance on your credit card. That’s wasted money.
- Try to put away at least 10% of your paycheck into a form of savings.
- Don’t keep all of your money in a checking account.
- At the very least, put it in savings
- Better, put it in a high yield savings account (I use ING Direct)
- Best, put some in a high yield savings account, invest the rest in an S&P 500 index fund. The best one in terms of low costs that I have found is the SSgA S&P 500 Index FUnd (ticker: SVSPX).
- Don’t be afraid or lazy about the investing. Invest at a young age. Don’t use mutual funds, use index funds (index funds have much lower expense ratios and always beat mutual funds in the long term as a whole)
- Don’t go out to eat all the time.
- Don’t buy a gas guzzling or flashy car if you don’t need it.
- Don’t buy more than “regular” gas unless your car requires more
- If your car isn’t worth much, don’t get collision insurance.
- If your workplace offers a 401k, take advantage of it. If they match your contributions, definitely take advantage of it, because that’s free money.
- Start an IRA while young
- Roth if you are in a lower tax bracket now than when you retire
- Traditional if you are in a very high tax bracket now compared to when you retire.
- Remember you cannot withdraw without penalty until you are 59 and a half years old.
- Keep a little bit of money around in an easy to access savings account in case of emergencies.
- Pay off loans BEFORE you put money in saving. The rates on loans are usually higher than the rates on savings accounts or the return on most investments, so pay off your loans as soon as possible.
Cash Advances Overnight payday loans
March 10th, 2006 at 12:46 pm
That’s right george…you tell em. ING has a function now that they will periodically take a certain amount from a linked account, so I am doing that to my assistantship checks. They get direct deposited into my BoA account, which gets funnelled into ING. Fairly easy…but you have to make sure that there are sufficient funds everywhere.
March 10th, 2006 at 12:55 pm
I like the automatic transfers, that’s a good idea, and it’s a good way to make sure you save. They also have those things for automatic investment accounts, for instance at sharebuilder.com or etrade.com, so it takes out a certain amount every month and puts it into an investment that you tell it to do, and you can usually avoid some transaction fees that way too.
Rock it and shock it, jon
March 21st, 2006 at 3:04 pm
Very good advice, George. You will retire wealthy if you follow your own advice.
The only parts I’d look at a little closer:
1) Paying off your loan as soon as you can if it is a home mortgage. A person can deduct the interest on their mortgage and the effective rate is sometimes lower than one can earn in a safe investment and a person can have liquidity.
2) Why not go for a total market index rather than one that mirrors the S&P500? More divirsity won’t hurt.
People should save more. But as you alluded, the savings rate is not a good measure of wealth accumulation. The savings rate does not take into account capitial gains on equity or real estate appreciation. Currently many people are using their home as a bank account and saving vechicle. Since home values have rapidly risen in many areas, many people take a loan out against their home for their kids college education or other needed expense.
People should diversify into different asset classes but many have to devote a large percent of their check to the mortgage each month that they cannot afford or think real estate will continue to skyrocket.
March 21st, 2006 at 7:03 pm
Thanks. Yeah, more diversity is not a bad thing. I mentioned the S&P500 simply because it’s an easy option.
I will agree that real estate is a pretty sketchy investment at the moment. Obviously that’s another reason why it’s good to diversify.
Have you ever looked into things like the “Coffeehouse portfolio?”
Right now I’m reading http://www.mymoneyblog.com, it’s really interesting stuff sometimes.
March 22nd, 2006 at 3:15 am
Ahhh man. I wrote a long response but tried to do a spell check on it and then deleted it by mistake.
I am not familiar with “Coffeehouse portfolio.”
Short version - The next book I plan to read is Unconventional Success
by David F. Swensen.
Diversification is the best way to increase expected return for a given level of risk. Malkiel has shown that a portfolio with real estate has a higher return than a traditional portfolio with S&P and government bonds.
March 22nd, 2006 at 8:16 am
You should totally check out “A Random Walk Down Wall Street” by David Malkiel. It’s talking all about diversification and the Capital Asset Pricing Model and such.
I’ll have to check out Unconventional Success sometime soon.
March 22nd, 2006 at 8:18 am
Actually, I just read the description of Swensen’s book, and I already agree with it. Mutual funds really are a waste of money compared with index funds or ETFs… and I totally feel like people get into mutual funds simply because they have one good year.
If I remember correctly, over a 10 year period, 98% of mutual funds do worse than a basic S&P 500 index fund purely because of administration costs.
March 22nd, 2006 at 11:02 am
Index funds perform better due to lower annual fees within in a fund and because they are much more tax efficient.
And a little more controversial point is what degree of efficient market hypothesis (EMH) is correct - weak, semi-strong or strong. EMH is the idea that securities markets are efficient, with prices of securities reflecting their economic value.
“A Random Walk Down Wall Street” by David Malkiel is said to be an excellent book. I haven’t read it. I have read texts that use a lot of Malkiel’s research. I am very impressed by the guy.
The random walk hypothesis says that prices for securities follows a random walk. It is very similar to the idea of a weak form efficient market. The price change for today is unrelated to the price change yesterday or the day before that. If new information arrives randomly to the market and investors react to it immediately, changes in prices will be random. Some people overreact to news (especially for smaller companies). So the price of securities goes above what the news should accurately indicate and then falls below what it should indicate.
The problem for investors is that trends in price changes, to the extent they exist, cannot be profitably exploited due to transaction and tax inefficiencies.
March 22nd, 2006 at 12:22 pm
Wow, you are already the coolest person on gimme-five in my book. I’m so glad somebody else keeps up with this stuff. I’m just learning about this all now in my financial markets class, so I will have lots more to say about the efficient markets hypothesis after the semester is over.
Are you involved in the field of economics/finance or are you just interested in it?
March 22nd, 2006 at 4:05 pm
I was an econ major with management minor in college. Looking back, I kind of wish I took more micro econ and finance courses than the political econ type course I took. Oh well. I was a math major my first two years and then switched to econ because I got lazy and I found out that the only math required for most econ courses was basic statistics and a little calculus. With a good statistics background, the econ classes I took were pretty easy. Though I hated econometrics.
I don’t work in the investing field. With most businesses moving from traditional defined benefit to defined contribution plans (which shifts the burden of risk on the individual) and with social security potential problems, I realized it is going to be increasingly important to be a knowledgeable personal investor if I want to want to have a comfortable retirement. So I have been trying to keep up on this stuff the last couple years.
Granted I haven’t taken many courses and am not an expert but you summarized about 90-95% of all I have read. You did a very good job. Most of the stuff in books on this topic will simply provide the evidence and reasons behind why an investor should follow your advice.
I am going to have to give a closer look to that blog. It looks like it provides very good information.
I’d like to take some more courses that CFAs are required to take to get their designation. Not because I want to be a CFA because I would hate that job. More so I get a more education on this topic.
However, I’ll have to wait until my wife finishes getting her masters. She will earn $10,000 more each year working as a teacher once she has a masters degree. In addition, the added annual income will increase her pension. I cannot think of any investment that will beat the return on this human capital or education investment. The cool thing is that working towards her masters degree hasn’t hurt her running. She was notified yesterday that she can participate with an elite number at Boston this year. She just turned 40 and will be competing as an elite master for the first time. Damn 40 sounds old but time goes fast. You are very wise to start saving and investing now because you will be old too before you know it.
I did a quick search on “Coffeehouse portfolio.” I will have to look more into what this is about.
March 22nd, 2006 at 7:30 pm
Ah ok cool. I am a econ major right now, when I entered school I wanted to be a computer science major and that didn’t work out so here I am. Econometrics was tough, but I didn’t mind it so much.
I definitely agree that it’s super-important to be knowledgeable about investing for the future, though. Many of my fellow college students roll their eyes at me when I mention that I’ve started an IRA, or that I check the stock market, or even that I move my money out of my checking account and into a savings account when I don’t need it. But then again, the average savings rate in the country, as noted in this article, is negative, so it’s clear that there are a lot of people out there that don’t give a crap… and they’ll pay for it down the road.
Are you a runner as well?
March 22nd, 2006 at 9:31 pm
I read about your marathon on Kilgore’s board. Congratulations on a fine effort.
Are you a runner as well?
No, I am just a garbage man. You are probably too young to get that reference.
While I will be doing Boston, my wife will be racing for the chance to win a crystal bowl or, if she is really really lucky, money. But she has been sick the last week and has not been able to run for 5 straight days. She is going crazy. She shouldn’t have lost too much fitness as long as she gets back on track and stays healthy from here until the race.
One additional point to consider is to put your income generating portion of your portfolio inside your IRA or other tax deferred or tax advantaged account and hold your total market or S&P500 index fund in a taxable account. You will be more tax effcient that way.
March 22nd, 2006 at 10:44 pm
a) Thanks!
b) Yes I am, I’ll admit I do not get the reference.
c) Wow that is awesome! I’m sure she’ll be fine though. I had a terrible calf strain 2 weeks out from my marathon, had to take a bit of time off, but thankfully it didn’t affect me during the race at all. Granted, now I can’t walk without a limp, but it’s a price I was definitely willing to pay. Good luck to both of you!
d) That’s an interesting point. I haven’t investigated the tax effectiveness of my S&P500 fund (SVSPX), but it does have very low fees so I assume it’s relatively tax efficient. I have a few stocks in my IRA right now that I trade every few months, and it’s nice to not have to worry about capital gains taxes on them.
And finally, did you see that google released a finance site? finance.google.com? It’s not very feature-rich yet, but it looks very nice and clean, and I like the graphs a lot. Perhaps it will compete with yahoo finance eventually…
March 23rd, 2006 at 1:48 am
You have it right. If you want to do a lot of trades, do it inside your IRA to avoid short-term capital gain taxes. However, good luck beating the market with individual stock trades. It is more difficult than you think and the risk/reward calculation works against you. When you buy the S&P500 index, you are only dealing with systematic or market risk. This is the risk attributable to broad macro factors affecting all securities. When you trade individual stocks, you face systematic as well as nonsystematic or non-market risk. This is the risk attributable to factors unique to that security. The bottom line is you are taking a lot of risk and a lot of uncertainty of return. Serious investors want to maximize their expected return for a given level of risk. Most people buying and selling individual stocks aren’t really considering the risks. They are trying to maximize return and not factoring in risk and that is speculation or gambling. That isn’t really investing.
Unless you think you can spot a market anomaly that you think you can exploit, which is very difficult to do effectively, I’d think twice about trying to beat the market with individual stock trades. If you want to do that with a small part of your portfolio so you can have something to talk about a parties, go for it. But realize that isn’t what you really should be doing to get the highest expected returns for your money.
Of course, the downside of you doing trades inside your IRA is that you cannot write off the $3000 in losses each year that you would be able to do if you made the same trades in a taxable account (if follow some basic qualifications).
An S&P500 index will be very tax efficient. If you have to have something in a taxable account, you will want something like an S&P500 index that is tax efficient.
Since you are young and have a high risk tolerance, you don’t need a big percentage of your portfolio in income generating assets so it doesn’t apply much to you. But older and less risk tolerant folks want a good portion of their assets set aside for bonds, high dividend paying stocks, or other income generating assets. They would be better off putting these assets in a tax deferred or Roth account because these investments are not tax efficient and the owners of these assets would have to pay taxes on their earnings each year, which would take a good bite out of their earnings, if they weren’t in a tax advantaged account.
I just read an article in the newspaper about google setting up a financial page while I was biking at the gym. I’ll have to check it out. IMO technical analysis is crap.
March 23rd, 2006 at 10:58 am
Yeah, I know that I won’t beat the market in the long term, but part of the reason I do it is purely for fun. Most of my money is in index funds and such, but I do have a bit of money in stocks just to stay interested. So far it’s worked out well, but I definitely understand the fact that it isn’t really the best way to go at all.
But yeah, technical analysis is total crap. If it worked, everyone would be a millionare, but since you can’t win when you do the same thing as everyone else unless you beat them to it, technical analysis is basically a paradox since not everyone can win if they follow it. [and it doesn't work in the first place, anyways].
The one thing I’m not quite certain of is when to start putting money in a traditional IRA vs. a Roth IRA. Do you think I should do it when my income gets high, or keep putting money in my Roth regardless?
March 23rd, 2006 at 3:23 pm
You have a very good handle on this stuff for a guy in college. I wish I knew what you know now when I graduated. I would have made more than $33.00 in one of the biggest best stock market years in the late 90’s. I made about .05% and the market was up around 30% that year.
The Roth vs Traditional IRA question is a good one.
I gave a good hard look at a very similar question earlier this year. The company I work for gave the option of contributing to a Roth 401(k) or a traditional 401(k) so I have done some work at studying this question.
There are lots of variables so I am not sure where to begin and I don’t want to bore you too much with little details.
First off, I’ll ignore some of the variables such as early withdrawals issues and minimum distributions issues ect.
Lets just look at the numbers and assume all those extra variables are the same for sake of simplicity.
There is no clear answer which option would be better to go with. You will have to make some wide-eyed assumptions. The first is what taxes will be like in the future. The second is what your income will be when you make withdrawals.
The run of thumb is spread the risk and put some of your money into a tax deferred account (a traditional 401(k) or traditional IRA) and a Roth IRA or Roth 401(k) account so you get tax diversification.
The rule of thumb really goes as follows. Contribute to your 401(k) to at least the match (as your list stated). After the match contribute to a Roth IRA. Then go back and contribute more to the traditional 401(k) or a traditional IRA if the company you work for doesn’t give you the option of a 401(k).
No one knows what taxes will be like when you will be taking withdrawals. If you assume the tax brackets are the same as today and you income today is the same as when you will be taking distributions, it doesn’t matter which option you choose. It is a wash. I made a spreadsheet to see this for myself. It is true.
If you think you will be in a higher tax bracket or you think there will be higher taxes overall and the income you will be making when you are taking distributions is a higher effective rate than today, you are better with a Roth. However, you cannot know for sure. Maybe the federal government institutes a sales tax or a flat tax that will reduce your effective income rate in the future. If that is the case and you went with a Roth, you would have paid more now in taxes than you would have later.
But assuming taxes are primarily collected by income tax in the future. If you think tax rates will increase and think you will have a lot of income in retirement, a Roth is the way to go. Tax brackets have been compressed and the rates have been lowered in recent years. At the same time, deficits are very high and will likely increase as baby boomers retire. Many people think tax rates will be higher because of this when they retire.
If you think you will receive substantial inheritances that will cause you to be in a higher tax rate in later years, a Roth would probably be the better option.
The bottom line is that it would be best to do some in both types of accounts. You spread the risk by through tax diversification like you would by buying different asset classes.
If you want me to go into the differences of some of the other attributes let me know.
February 3rd, 2007 at 9:35 am
Savings rate is a fairly poor indicator of total saving. By reading through the comments and article the recomendation is to put as much into a 401(k) as will be matched. Unfortunately that will do nothing to help the savings rate even though the person is savings. This is because that is pre tax savings and the savings rate is a post tax measurement. Thus 401(k) contributions do not “count” even though millions of Americans use them every year.
Interestingly the savings rate peaked in 1977. What is the significance of this year? Well in 1978 401(k) plans came out and the savings rate started a decline.
Real estate investments are not great in the short run perhaps but over the long haul they are a very worthwhile investment. One that many Americans have been investing in.
Here is an excerpt from a NY Times article which concludes that Americans are perhaps saving too much:
” Nevertheless, the loose confederation of well-regarded economists, who have not been working in concert, say their research points to the startling conclusion that many Americans are saving too much, not too little. Indeed, their studies of the savings and spending habits of the generation born between 1931 and 1941 revealed that at least 80 percent had accumulated more than enough wealth for retirement. While they have not studied the baby boom generation as closely, they believe that the greater wealth of that generation should also leave those retirees secure.
A study last October by another group of economists, including two working for the Federal Reserve Board, found 88 percent of retirees age 51 and older had adequate wealth.
“Even the most casual reading of the popular press will have you convinced that Americans are heading like lemmings over a cliff,” said John Karl Scholz, an economics professor at the University of Wisconsin at Madison. “Going into this, I had no idea that we’d find any results anything like this.””
February 3rd, 2007 at 10:27 am
Hm, I suppose I never really knew that, so thanks for bringing that point up. I’ll agree that perhaps the savings rate is a bit skewed, yet I would never go so far as to say that people are “saving too much” or even adequately.
Why? First off, as of 2005, the ratio of household debt to disposable income was an all time high (http://www.frbsf.org/publications/economics/letter/2005/el2005-30.html).
And there seems to be conflicting data with that which you cited on whether Americans are ready for retirement. In ‘04:
Finally, even if Americans are putting tons of money into 401ks (I doubt they’re putting enough in to skew the personal savings rate statistic this much), they are neglecting to keep a “rainy day fund” around for emergency expenses, which is poor financial practice.
I wouldn’t say the current financial planning of Americans is stellar/adequate.