For years, we have heard that our personal savings rate is dismally low. However, that knowledge has not led to an increase in savings. Instead, personal savings as a percentage of disposable income has continued to hover at historically low levels, 0.9% in 2004 (Source: The Regional Economist, July 2005).
How concerned should we be by this trend?
The Importance of Savings
At first glance, it appears that savings hurt the economy. If consumers save rather than spend their income, current sales for stores, service establishments, and manufacturers will decline, putting a damper on jobs and income. However, this is only a short-term effect.
Over the long term, these savings are used to make investments, which finance modernized equipment, new construction of homes and factories, and research and development of new products. These investments, in turn, create more jobs and more income.
However, savings in our country come from three sources - individuals, businesses, and the government. While the individual savings rate has been declining, the savings rate of businesses has risen significantly. Business savings comprised 93% of total national savings in 2003 and 2004, compared to 65% in the early 1950s (Source: The Regional Economist, July 2005). Government saving has tended to be positive due to surpluses run by state and local governments, while substantial investment by foreigners has also helped our national savings.
The Impact on Individuals
There is some debate over how much significance should be placed on the decline in the personal savings rate, since it only measures what percentage of disposable income individuals are saving each year. It does not factor in changes in wealth attributable to gains in investments and real estate.
Yet, even when accumulated assets are considered, most studies generally conclude that the baby boomers are not saving enough for retirement. For instance, the Employee Benefit Research Institute's 2005 Retirement Confidence Survey found that only 69% of Americans had saved any money for retirement. Of those who had started saving, 65% had less than $50,000 of savings.
One study found that baby boomers are only saving about one-third of the amount needed to retire comfortably (Source: Accounting Today, June 5, 2005).
This is alarming when you consider that the baby boomer generation may be the first generation to have to finance a significant portion of their own retirements. The baby boomer's grandparents typically did not retire - most men worked until they died. The baby boomer's parents started the retirement trend, but they retired on other people's generosity. Generous pension benefits and Social Security benefits indexed for inflation allowed them to retire to a comfortable lifestyle, without saving much on their own.
While savings have always been important to this country, many see increased personal savings as the only way to ensure that the baby boomer generation will be able to enjoy their retirement years. Corporations are increasingly moving from defined-benefit pension plans, where they make contributions, to defined-contribution plans, where employees must make contributions. The financial cost of providing current Social Security benefits to the huge number of baby boomers may mean that the system will have to be changed. Thus, savings will be very important to the future standard of living of a significant portion of the population.
While the debate over the significance of the declining personal savings rate will continue, on an individual level, it should serve as a wake-up call to reassess how much progress we are making toward our retirement goals.