Surging U.S. Savings Rate Reduces Dependence on China
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Nouriel Roubini, an economics professor at New York University and chairman of RGE Monitor, forecasts that the savings rate will ultimately reach 10 percent to 11 percent. What’s critical, he said in a Bloomberg Television interview on June 24, is how quickly it increases.
A rapid rise in the next year because of a collapse in consumption would push the economy, already in its deepest contraction in 50 years, further into recession, he said. If it occurs over a few years, the economy may grow.
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From 1960 until 1990, households socked away an average of about 9 percent of their after-tax income, government figures show. Americans got out of the habit in the 1990s as they saw their wealth build up in other ways, first through surging stock prices and then soaring home values, Gramley said.
That process has now gone into reverse. U.S. household wealth fell by $1.3 trillion in the first quarter of this year, with net worth for households and nonprofit groups reaching the lowest level since 2004, according to a Fed report. Wealth plunged by a record $4.9 trillion in the last quarter of 2008.
Edmund Phelps, winner of the Nobel Prize in economics in 2006 and a professor at Columbia University in New York, said it may take as long as 15 years for households to rebuild what they lost in the recession.
As I have been saying the living beyond our means must stop. Those that think health of an economy is only the GDP forget that if the GDP is high due to spending tomorrows earnings today that is not healthy. Roubini correctly indicates the speed at which savings increases could easily determine the time we crawl out of the recession. I hope the savings rate does increase to over 10 percent.
If we do that over 3 years that would be wonderful. But it is more important we save more. If that means a longer recession to pay off the excessive spending over the last few decades so be it. And it is going to take a lot longer than a few years to pay off those debts. It is just how quickly we really start to make a dent in paying them off that is in question now (or whether we continue to live beyond our means, which I think it still very possible – and unhealthy).
Related: Will Americans Actually Save and Worsen the Recession? – Can I Afford That? – $2,540,000,000,000 in USA Consumer Debt (April 2008) – Paying for Over-spending
John Bogle was the founder of Vanguard Group and a well respected investment mind. He has written several good books including: The Little Book of Common Sense Investing, Common Sense on Mutual Funds and Bogle on Mutual Funds. This interview from 2006 discusses the state of the retirement system, before the credit crisis.
Frontline: How do they get away with that? Don’t they have to fund them?
John Bogle: No, they don’t, because a lot of it is based on assumptions. Our corporations are now assuming that future returns in their pension plan will be about 8.5 percent per year, and that’s not going to happen. The future returns in the bond market will be about 4.5 percent, and maybe if we’re lucky 7.5 percent on stocks. Call it a 6 percent return — before you deduct the cost of investing all that money, the turnover cost, the management fees. So maybe a 5 percent return is going to be possible, in my judgment, and they are estimating 8.5 percent.
Why? Because when they do it that way, corporation earnings become greatly overstated, and all the executives get nice, big bonuses. They are using pension plan assumptions as a way to manage corporate earnings and meet the expectations of Wall Street.
Frontline: So if a company overstates the value of its pension plan assets, it makes the company look better to Wall Street, so there’s an incentive to kind of exaggerate, if not cheat.
John Bogle: That is precisely correct. And let me clear on the cheating: It’s legal cheating; it’s not illegal cheating. In other words, you can change any reasonable set of numbers — and corporations have done this, have raised the pension assumption from 7 percent to 8.5 percent — and all of a sudden that corporation will report an earnings gain for the year rather than an earnings loss that they would otherwise have. Simple, legal.
The entire PBS series (from 2006) on 401(k)s (including interviews with Elizabeth Warren, David Wray and Alicia Munnell) is worth reading.
In February of 2009 he spoke to the House of Representatives committee exploring retirement security.
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Consumer borrowing falls in March at fastest pace in over 18 years, Americans saving more
In dollar terms, consumer borrowing plunged by $11.1 billion. That’s the largest dollar amount on records dating to 1943, and more than three times the $3.5 billion drop that economists expected. The borrowing category that includes credit cards dropped 6.8 percent in March after a 12.1 percent plunge in February. The category that includes auto loans fell 4.2 percent after rising by 1.2 percent in February.
The Commerce Department last week said that the personal savings rate edged up to 4.2 percent in March, marking the first time in a decade that the savings rate has been above 4 percent for three straight months.
Good. Consumer debt is far to large and should be paid down. This is a start but a small start, but a much larger reduction in outstanding consumer debt is needed before we have reached a healthy level of debt. The continued improvement in that debt level signifies a stronger economy. Far too many financial journalists instead of pointing out the benefits of such improvement note that this reduces current consumption (and thus, effectively, will lower current GDP – compared to what it would be if we continued to spend beyond our means). You cannot spend money your don’t have forever.
Having more stuff in your house (along with an increased outstanding credit card balance) does not make you economically more successful. And the same holds true for the economy. Having more stuff sitting in people’s house and an increasing debt load is not the sign of a stronger economy (even if it is a route to a higher current GDP). Increased saving and reducing debt will strengthen the economy and improve our economic success over the long term.
Related: Will Americans Actually Save and Worsen the Recession? – Proper credit card use – Personal Saving and Personal Debt in the USA – Americans are Drowning in Debt – Buying Stuff to Feel Powerful
Diversification overrated? Not a chance by Jason Zweig
For anyone with a sustainable ability to identify the hottest investment of the moment, diversification is a mistake. But if you really believe you’ve got that ability, you’re not just mistaken. You need to be hauled off in a straitjacket to the Institute for the Treatment of Investment Insanity.
Exactly right. As we posted previously Warren Buffett’s diversification thoughts are similar
You have to remember when Warren Buffett says “professional and have confidence” he doesn’t really mean just what those words say. He mean if you are Charlie Munger, George Soros, Jimmy Rodgers and maybe 10 other people alive today (maybe I am too restrictive, maybe he would include 50 more people alive today, but I doubt it).
Related: Dilbert on Investing – investment risks – Curious Cat Investing and Economics Search Engine
Feds Rethink Rules on Retirement Savings
Among the possible changes: allowing taxpayers to delay taking required withdrawals from their individual retirement accounts, 401(k) plans and other similar accounts this year — or at least reducing the amount that must be withdrawn. Also under consideration are various ways to provide tax relief for people who already have made their required withdrawals for this year.
This is silly. Everyone in the situation of having to make a withdrawal has know about the requirement for years. My guess is this has been the law for over 20 years. Yes, the stock market is down. Yes, being forced to sell now would be bad. And how does providing “tax relief” to those who already made required withdrawals make any sense? Why not just have the treasury send checks to every American, who had a loss on an investment this year, equal to the amount of their loss? (By the way this is sarcasm – they should not really do that). These people have lost any sense of what investing, planning, responsibly… are.
First, knowing you have required withdrawals from your IRA, you should not hold those assets in stock (I suppose you could have significant cash assets outside your IRA and chose to just use the next option). Second, you can buy the stock outside your IRA at the same minute you sell them in the IRA. What is the big deal: the cost should be about $20 in stock commission for each stock – you save that much each time you fill up your gas tank lately (compared to prices this summer). All that not having to withdraw funds does is let those wealthy enough not to need a small amount of their IRA or 401(k) savings by the time they are 70 1/2 to keep deferring taxes on their investment gains.
Therein lies one of the major problems. This year’s distributions are based on Dec. 31, 2007, levels — a time when market prices generally were far above today’s deeply depressed values. As a result, “millions of Americans are forced to withdraw larger-than-anticipated amounts from already-depleted retirement funds,” says David Certner, legislative policy director at AARP, an advocacy group that represents nearly 40 million older Americans.
What kind of 1984 newspeak is this? I mean this is absolutely ridicules. You have to withdraw the exact amount you knew on January 1st 2008. Nothing about that has changed in almost a year. How can the Wall Street Journal report this without pointing out the completely false claim.
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Why Allocations Make A Big Difference
Good advice, but I believe people need to be much more careful with bonds than many people believe. Long term bonds can be volatile (both due to interest rate and other risks). And with interest rates low this risk is higher. The duration of your bonds (as well as credit/business risk) is a very important factor (the longer the duration the higher the interest rate risk).
I also think the importance of asset allocation increases as your assets increase and the goal gets closer (normally retirement but also could be a child’s education fund…). And I think you need to look at more than just stocks versus bonds (different types of stocks, real estate… are important considerations). I discussed some possible retirement account allocations possibilities for early in life in a previous post.
Related: Lazy Portfolio Results – Investing books – Roth IRA – Dollar Cost Averaging
Retirement planning is a huge financial need and one of the areas where financial literacy can pay off very well. Understanding the incredible power of compound interest can be used to start your retirement savings early and provide you with a huge benefit. Understanding the risks of inflation can guide your investment decisions. The recent Business Week Retirement Guide is very good. In Spending Safely, they explore how to spend while preserving your capital in retirement.
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Bengen now suggests that the 4% figure – actually 4.1% for a 60/40 portfolio of large caps and bonds and 4.5% if you toss in small caps – merely seems impressive when plugged into Excel (MSFT) spreadsheets. In practice, the strategy, which Bengen stopped using with his own clients about three years ago, is inflexible and unrealistic he says – and the formula is too stingy.
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Flexibility is factored into Bengen’s revised approach, which permits withdrawals to fluctuate within guidelines. His “floor-and-ceiling strategy” suggests that an initial withdrawal rate of 5.16% would be appropriate if a retiree pares back subsequent withdrawals by as much as 10% of the initial withdrawal during hard times (the floor). On the other hand, a retiree could withdraw extra cash equaling up to 25% of the first-year withdrawal (the ceiling) when the market is strong.
This adjusted thinking is correct I believe. People want simpler answers but some things just require a more complex understanding.
Related: How Much Retirement Income? – Add to Your Roth IRA – Retirement Tips from TIAA CREF – Our Only Hope: Retiring Later
Failing to save is a huge problem in the USA. Spending money you don’t have (taking on personal debt) and not even having emergency savings and retirement savings lead to failed financial futures. Even though those in the USA today are among the richest people ever to live many still seem to have trouble saving. Here is a simple tip to improve that result for yourself.
Anytime you get a raise split the raise between savings, paying off debt (if you have any non-mortgage debt), and increasing the amount you have to spend. I think too many people think financial success is much more complicated than it is. Doing simple things like this (and some of the other things, mentioned in this blog) will help most people do much better than they have been doing.
There are lots of ways to spend money. And many people find ways to spend all or more than all (credit card debt, personal loans…) they have which are sure ways to a failed financial future. So anytime you get a raise (a promotion, new job…) take a portion of that extra money and put it toward your financial future. The proportion can very but I would aim for at least 50% if you have any non-mortgage debt, don’t have a 6 month emergency fund, or are behind in saving for retirement, a house…
Exactly how you calculate if you are behind, I will address in a future post (or you can look around for more information). By taking this fairly simple action you will be setting yourself up for a successful financial future instead of finding yourself falling behind, as so many do. And then when things go badly, as they most likely will sometime during your life, you will have built up a financial position to draw on. Instead of, as so many do now, find that you were living beyond your means when things were going well – which it doesn’t take a genius to see will lead to serious problems when things take a turn for the worse.
So lets say you take a new job and get a raise of $4,000 a year. Instead of spending $4,000 more just put $2,000 away (pay off debt, add to your retirement savings, add to savings for a house, add to your emergency fund…). Then you get a promotion of another $3,000, increase your spending by $1,500 and save the rest. It is such a simple idea and just doing this you can find yourself in the top few percent of those making smart financial decisions. And if you get to the point that you are ahead in all your financial areas then you can take more of each raise you get (but most of the time you will have learned how valuable the extra saving are and figured out the extra toys really are not worth it). But if you want to, once you have created a successful financial life, you can choose to buy more toys.
Related: Retirement Savings Survey Results – Earn more, spend more, want more
Graduates should put off living large after college
The key, experts say, is a simple one: Live like a poor college student for a couple more years. While you’re doing that, you can pay off your debt, start a savings plan and embrace healthy habits that will serve you well for life.
This is exactly what I did. Outside of paying for college, extra living expenses in college were small. Just retaining the spending habit of college gets your personal finances off on a good start.
Patty Procrastinator lives a little better when she first gets out of college and doesn’t start saving in the 401(k) until she’s 32. From that point, she also saves $500 a month, her employer adds $250 a month, and she earns a 9% return — just like Sallie. But at age 65, Patty will have only $1.7 million. That decade of delay will cost Patty $2.4 million.
Incidentally, Sallie contributes from her own money just $60,000 more than Patty does. The rest of the difference comes from employer contributions and investment returns.
By immediately starting to save for retirement and other needs you create a great foundation for your finances. Start saving for a house, a new car, create an emergency fund… Then you can create a situation where the only loans you need to take are for a house and maybe a new car – avoiding credit card debt or other personal loans.
Related: Personal Finance Basics: Health Insurance – Initial Retirement Account Allocations – Why Americans Are Going Broke
So lets say you have a 401(k) and are adding to it regularly, you own your house, you have no credit card debts, you are paying off your car loan and overall your financial house is in fairly good order. Still you keep hearing the news about credit crisis, mortgage meltdown, dollar depreciation… It is enough to make you nervous but what should you do?
Frankly very little in the macro economy has much impact on what is a smart long term strategy. Should you move your retirement money into a money market fund, because of the risks of stocks now? No. If you are good enough to time the market you are already amazingly rich (or will be soon). But either no one is able to do this or next to no one is. Occasionally you might get lucky and time things right but being able to consistently do so over 40 years is just not something that happens.
So what you should do now is what you should always do. Have cash savings. Pay off your mortgage (don’t over-leverage yourself – don’t take out equity just because you have some). Save for retirement. Have health insurance. Don’t take on credit card debt (or most other debt). Keep up your employment skills (learn new skills…). Diversify your investments (stocks, international stocks, real estate, cash…).
People often get careless when the overall economy is good. And so maybe you failed to do what you should have been doing then. But the right thing to do today is essentially the right thing to do always. For example, Americans are drowning in debt. They were also drowning in debt 3 years ago. That problem is the same. If you have too much debt you should fix that. Not because of all the fear today, but because to much debt is always bad. You should not take out too much debt in the first place and if you have to much you should fix it whether the economy is strong or weak.
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