Unemployment is low and the stock market is high, two signs which might lead some to believe the U.S. economy is on a roll. But there’s a hidden danger lurking within economic data that suggests trouble could be looming; Americans aren’t saving for the future. Again.
The personal savings rate, which had risen sharply in the wake of the Great Recession, is falling, fast.
Every personal financial advisor will tell you that the single most critical thing a consumer can do to ward off financial problems is create and maintain a strong emergency savings account. The standard advice: Have at least 3 months of living expenses socked away in a safe, risk-free savings account. (Six months is even better).
Still, plenty of Americans don’t, or can’t, follow that advice. Depending on how you ask, roughly half of U.S. consumers don’t even have one month’s savings, and couldn’t handle a single emergency, like an emergency transmission repair.
There’s plenty of reasons for this, but the most obvious: People are spending more than they are earning, so there’s nothing left to save at the end of the month. Maybe they spend too much. Maybe they haven’t gotten a raise in a long time, so inflation is eating up their spending power. Maybe they think their rising home value will save them. Whatever the reason, it’s a precarious situation.
Back in the 1960s and 70s, U.S. families typically saved roughly 10 % of their personal disposable income, according to the U.S. Federal Reserve. That percentage fell steadily during the 80’s and 90’s, and hit rock bottom at just below 2 percent on the eve of the housing bubble collapse. The recession seemed to nudge consumers into more conservative spending habits, and by 2012, the savings rate had perked back up to double-digits.
Those days seem to be over. After a mini-peak in 2015 at about 6 percent, savings rates have fallen pretty steadily and now sit at 3%…not far from where they were before the last recession. That’s barely enough to keep up with inflation, meaning in real terms, on average, Americans aren’t really saving anything.
Sam Ouliaris and Celine Rochon, in a working paper for the International Monetary Fund published recently, called out this trend, warning that recessions are often preceded by low personal savings rates.
“This issue has implications for the outlook for U.S. consumption and GDP growth, financial market stability, and external imbalances,” the authors write.
It’s hard to know exactly what this implies. Fundamentally, a low savings rate means consumers are spending instead of saving, and that can be a good thing for industries and markets. When consumers hoard cash, as they did in 2008-2009, it means they are pessimistic about the future. When they spend, they are optimistic, and they buy more. In an economy that’s driven mostly by consumer spending, that’s good. But when consumers are spending money that they aren’t earning, this is a short-term boost that’s going to end one way or another.
Consumers’ reluctance to save isn’t irrational. After all, passbook savings rates continue to be historically low — though they are inching up ever so slightly in the past 24 months. Plenty of Internet-based high-yield savings accounts and CDs now offer more than 1% APR.
Still, even with those less-than-sexy returns, it’s absolutely crucial to have a sizable savings account ready for emergencies. Otherwise, you could be forced to turn to high-cost alternatives like payday lenders in an emergency. Or, you might fail to pay some bills on time, which would really hurt your credit score.
Tricks to Save More
There are ways to nudge yourself into better savings habits. Automated savings accounts are a great start. This is sometimes known as the “pay yourself first” strategy. Tell your financial institution to move money into a savings account every payday, before you even get to “feel” the income. Consumers like this option. According to a recent survey by Mercator Advisory Group, “at least 3 in 5 consumers would be interested in automated savings plans, support for budgeting, or tracking progress toward goals from their financial institution.”
A novel twist on this idea is known as the “Save More Tomorrow” plan designed by Nobel Laureate and behavioral economist Richard Thaler. Promise yourself that whenever you get a raise or bonus, some percentage of that new money will go directly into savings – don’t let it slip into your monthly budget. Studies show consumers are far more effective at building up an emergency fund when they pledge future increases towards it. Some companies offer this option directly through payroll systems, but you can set it up through your financial institution.
Another method that “tricks” you into savings is the “separate account” strategy. Don’t just throw savings into a savings account. Create a new account that’s labeled specifically towards a goal: A “new car” account, or a “down payment” account, for example. Mercator says this strategy is really picking up steam with consumers. Some 65% of American consumers had such a goal-oriented fund set up in 2017, compared with 60% the year earlier. And 39% said they had plans to open up such an account, compared to 34% in 2015, Mercator said.
The strategy works partly for mechanical reasons – it creates a firewall which will make you less likely to raid the account – but other research suggests it works on an emotional level, too. Dr. Joe Kable, a neuroscience professor at the University of Pennsylvania, has done a lot of research into the reasons people make financial decisions. He believes that a good imagination is a big help, in this way: People saving for a car who are good at imagining that new car smell are often better at sticking to a savings plan. The key is a really visceral sensation, and being good at imagining just how great it will feel to slip into a brand-new set of wheels. Whenever temptation arises to make a bad choice, imagining that future feeling can help fight off the urge to spend today. Naturally, a separate savings account designed just for a new car can help you remember exactly why you are denying yourself a more immediate purchase.
Of course, a healthy savings account can’t control whether the U.S. economy hits a bump in the future. But it will make you better prepared if and when trouble arrives.
If you’re concerned about your credit, you can check your three credit reports for free once a year. To track your credit more regularly, Credit.com’s free Credit Report Card is an easy-to-understand breakdown of your credit report information that uses letter grades—plus you get two free credit scores updated every 14 days.