MONEY The Economy

The Surprising Reason You Need to Save More

While households are encouraged to spend for the good of the economy, history shows that high savings rates actually correspond with strong economic growth.

Does the U.S. save enough?

I’ve heard lots of rhetoric spilled on that question, but few facts.

That’s why I was intrigued by an analysis published this year by Ned Davis Research. The investment research firm looked at seven decades of data and compared “net national savings” with real growth in the U.S. economy.

National Savings

Net national savings is the sum of all the savings by individuals and families, corporations and the government. This number is then divided by gross domestic product (GDP) to get the national savings rate. Here are some of the findings:

* A “high” savings rate of 8.2% or better corresponded with an annual rate of GDP growth of 3.6%, on average.

* A mid-level savings rate of between 2.8% and 8.2% corresponded with GDP growth of 3.4%.

* And a “low” rate of below 2.8% corresponded with GDP growth of only 2%.

The conclusion: “The more money people have in savings, the more money there is to invest, and the better the economy performs,” wrote Ned Davis, head of the research firm.

During and after the financial crisis of 2007-2009, the savings rate plunged into the low zone, and actually turned negative in 2010 and 2011. Only very recently has the savings rate — barely — climbed back into the medium zone.

“The net national saving rate is greatly improved,” Davis wrote, but remains in “troublesome territory.”

Personal Savings

The personal savings rate (leaving government and corporations out of the picture) also deserves close attention. For years in the 1960s and 1970s it stayed near 8% of household income or above. In 2006-2007 it fell to around 3%, and lately has climbed back up to around 5%.

US Personal Savings Rate Chart

US Personal Savings Rate data by YCharts

Is that enough to finance a new boom in the U.S.? My guess is probably not. I’d like to see the personal savings rate resume its historic rate of 8% or more.

What Can Be Done?

Suppose the U.S. wants to improve its national savings rate? What needs to be done? To me, two things stand out.

First, we need to cut the budget deficit, probably through unpleasant but necessary measures such as making Social Security and Medicare slightly less generous. Why pick on these popular and important programs? For a simple reason: That is where almost half the money in the Federal budget goes.

Defense spending, which accounts for roughly 20% of the budget, can’t go unscathed either.

Second, if we want people to save, we need to wean ourselves gradually off the emergency medicine of super-low interest rates that was used to head off a potential depression in 2008. From 1990 through 2008, the average rate paid on savings account was 4% or more almost every year — sometimes much more. Today it’s around 1.75% or less.

No one wants to throw a monkey wrench into the economy’s engine by raising rates too abruptly too soon. But if we want people to save, it would help to pay them something to do it.

John Dorfman is chairman of Thunderstorm Capital LLC, a money management firm in Boston.

MONEY Investing

Are You On Your Way to $1 Million? Tell Us Your Story.

There are many ways to build lasting wealth. MONEY wants to hear how you're doing it.

The number of millionaires in America hit 9.6 million this year, a record high and yet another sign that the wealthy are recovering from the Great Recession, thanks in large part to stock market and real estate gains.

Are you on target to join their ranks? Are you taking steps—through your savings, your career decisions, your investments, or your rental properties—to make sure that by the time you retire your net worth will be in the seven figures? MONEY wants to hear your story.

Related: Where Are You On the Road to Wealth?

There are many paths to that kind of wealth, and they don’t necessarily involve a sudden windfall, a big head start, or a six-figure salary. You can build up a million or more in assets through steady saving, a sensible approach to investing, modest real estate holdings, or a winning small business idea. Are you finding ways to boost your savings at certain point of your life, like when the kids are out of school or the mortgage is paid up? Are you planning to take more or fewer risks with your investments as you near retirement? And if you invest in real estate, do you find that owning even one or two rental properties is enough to achieve prosperity?

Got a story like this to share? Use the confidential form below to tell us a bit about what you’re doing right, plus let us know where you’re from, what you do for a living, and how old you are. We won’t use your story unless we speak with you first.

MONEY retirement planning

Saying No Put Me on the Path to Financial Independence

House key in ring box
Dmytro Lastovych—Alamy

How I learned delayed gratification means opening the door to your true goals, like a home or a comfortable retirement.

I was raised around a lot of money—not my own, but other people’s. Granted, by any reasonable national standard my family was well-off, but growing up in New York City meant that my playmates were the children of media moguls and Wall Street titans, so my comparison group skewed upwards several tax brackets. For a while this environment created both a sense of longing and, unfortunately, entitlement. Everyone else has a summer home, why can’t we?! That feeling of financial inadequacy turned out to be a blessing in disguise however, because it taught me what those moguls and titans probably already knew, which is that the most satisfying wealth is the kind that you create for yourself, dollar by dollar by dollar.

Financial independence is certainly easier to achieve with a good income. But you can also get there, or at least come close to it, by saving and investing no matter what your salary is. (See The Millionaire Next Door.) And so at the most fundamental level, independence requires that you always live well within your means. If you are not living within your means, then you are not saving, and if you are not saving, then you are not creating wealth, you are creating the opposite: need. Financial independence means not having need.

There is no saving without delaying gratification, saying no when you want to say yes—not just every once in a while but pretty much constantly. Saying no not just to the big trips or a car, but also to the expensive haircuts and the overpriced appetizers and the ballet flats with the big logo on them when a pair from DSW will do just fine. It means being chronically cheap and enjoying it. Because every no is a yes to getting things that you really, really, really want and can truly fulfill need, no matter what stage of life you are in.

In my 20s and early 30s, my biggest need, after I had established myself on a career track, was to have a place of my own. I had bounced from illegal sublets to 4th floor walk-ups and had literally begun dreaming of “discovering” an extra room in whichever cramped apartment I was occupying, a dream that I later found out was shared in the collective unconscious of similarly space-starved young Manhattanites.

At the outset, buying my own one bedroom seemed an impossibility. But after a job switch and salary raise, I began automatically withdrawing money from my checking account into a house fund. After several years, I had saved $60,000, at which point several of my relatives generously gave me gifts to increase my down payment and create enough of a cushion to meet co-op board approval. Buying that apartment at age 32 was my first major milepost on the road to financial independence, but I didn’t do it alone.

Related: Where are you on the Road to Wealth?

They helped me, I believe, because I had shown them that I understood what building wealth entailed: being a good steward of your own money, understanding that you have to teach yourself the things you don’t know, whether that’s fixed-rate versus adjustable mortgages or the value of compound interest, and yes, delaying gratification. Granted, timing was on my side—I bought the apartment in the early stages of the real estate boom as was able to later profit not only on its sale but the sale of a subsequent, larger apartment.

But having saved for a purpose once, I know that I can do it again in the future, although not whenever I want but whenever I am able. I would love to be putting aside money to install a master bathroom in my house, but right now it’s more important that my children, with whom I currently share a bathroom, have good childcare, and that I increase my funding to my retirement accounts. The master bath will have to wait.

So here’s where I’m going to get really preachy, because there’s actually another important lesson that all this delayed gratification has taught me. There will always be more and more things to save for: sleep-away camps, college funds, maybe even someday a summer cottage. Today, as I write this on a beautiful day at the end of June, I can honestly say that the path to financial independence also means being profoundly grateful for what you already have.

Ruth Davis Konigsberg, a fortysomething journalist and consultant to Arden Asset Management, writes weekly about retirement planning.

MONEY 401(k)s

This Nobel Economist Nails What’s Really Wrong with Your 401(k)

Robert Merton, a Nobel laureate and finance professor at the Massachusetts Institute of Technology
MIT professor Robert Merton John Hanna—AP

Retirement plans are doing it all wrong, says Robert Merton. He ought to know. His hedge fund nearly brought the down the global economy.

In the 30-plus years since 401(k) plans were first introduced, they’ve faced criticism for everything from the risks employees face to the fees they pay to poor investing options. Now Robert Merton, a Nobel Prize-winning economist, says 401(k)s are headed for a crisis.

If anyone should know about a potential crisis, it’s Merton. Along with his fellow Nobel laureate Myron Scholes, Merton co-founded and sat on the board of Long-Term Capital Management, a hedge fund that was managed based on complex computer models. Under the leadership of co-founder John Meriwether, LTCM’s massive failure nearly brought down the global economy in 1998.

Now Merton is saying that 401(k)s are headed for trouble, but for very different reasons. In particular, he argued at a recent Pensions & Investments conference, 401(k)s take exactly the wrong approach to retirement investing by emphasizing account balances and investment returns, thereby encouraging savers to amass the largest portfolio possible, which pushes them to take too much risk. That’s an approach he calls “la-la land.”

Instead of focusing on wealth creation, 401(k)s should emphasize the level of income employees can expect to receive in retirement, Merton says. By knowing whether they are on track to that goal, workers will make better saving and investment choices.

One of the best ways to be assured of steady future income is to invest in an inflation-adjusted annuity, Merton says. But current 401(k) regulations do not allow deferred annuities as an investment option. Merton argued in a recent Harvard Business Review article that this barrier should be changed.

Meanwhile, workers are encouraged to invest in Treasury bills for safety, which they appear to deliver — if you look at year-by-year returns. But if you consider the income that T-bills would provide in retirement, as measured by the amount of deferred annuity income they would purchase, they are nearly as risky as the stock market. “The seeds of the coming pension crisis lie in the fact that investment decisions are being made with a misguided view of risk,” Merton writes.

Even so, he isn’t recommending that investors hold only deferred annuities to achieve their income goals. Instead, he suggests investing in a mix of stocks as well as bonds and deferred annuities. Over time, that asset allocation should shift based on the likelihood of achieving the investor’s income goal. At retirement, the worker would have enough money to buy an annuity that would provide the target salary replacement amount. But the choice would be left up to the employee. Still, Merton clearly has an opinion about what option is best, as a recent MarketWatch article noted. “When we take a risk, it’s generally for a good reason. You wouldn’t normally put yourself in harm’s way for no reason,” Merton writes.

Problem is, figuring out the right portfolio strategy, and when to make those shifts, is a tough challenge for the average investor. And not so coincidentally, Merton has a solution, which is to rely on professsional investment managers to handle this for you. An MIT professor, Merton is also the “resident scientist” at Dimensional Fund Advisors, which offers a 401(k) plan that focuses on producing a reliable income stream. (For more on DFA’s approach, see “The End of Investing.”)

The DFA connection aside, Merton’s insights are well worth considering. Along with Scholes, he won the Nobel in 1997 for a landmark options-pricing theory, called the Black-Scholes model, that is still widely used. (Economist Fisher Black passed away before the Nobel was awarded.) And in his call for 401(k) reforms, Merton has plenty of company. A growing number of academics and 401(k) providers advocate an income approach. So does the U.S. Labor Department, which intends to require plan providers to present investors with statements showing their projected income in retirement. Some investment groups already do.

Even if your 401(k) plan doesn’t offer income projections, you can get find calculators online that will give you estimates. Just remember, they are only projections, and if you don’t keep checking your assumptions, models can steer you astray. Just ask Robert Merton.

Update 7/1: The U.S. Treasury today approved the option of deferred annuities in retirement plans.

Related story: The New 401(k) Income Option That Kicks In When You’re Old

 

TIME Retirement

Americans Are Totally Unprepared for This Shock

Sad piggy bank
Simon Critchley—Ikon Images/Getty Images

Never mind saving for retirement: Americans today face the bleak prospect of poverty in their golden years because they have no idea how much nursing homes cost and they wildly underestimate how much they’ll need.

In a new survey by MoneyRates.com, 40% of respondents say they’ve set aside nothing — zilch — towards paying for the care they’ll most likely need in their final years.

“Over two-thirds of individuals who reach age 65 will need long-term care services during their lifetime,” the Centers for Disease Control and Prevention warns.

Two-thirds of survey respondents have less than $75,000 saved. More than half think $75,000 is more than they’ll need for a year in a nursing home, but they could be in for a rude awakening: The average cost for a semi-private room in a nursing home is more than $81,000 a year, and that can soar to nearly $142,000 in pricey locations like New York City.

“It’s scary how quickly nursing care can run through your savings,” says Richard Barrington, senior financial analyst for MoneyRates.com. Barrington says even people who think they’re being diligent about saving for their retirement years can be led astray by the assumption that they’ll be able to live on less money after they exit the workforce.

“You may have a fair amount of discretion in the early years of your retirement, but then your financial needs may accelerate sharply,” he says. “People need to plan their savings and conserve their resources accordingly.”

A new brief from Boston College’s Center for Retirement Research illustrates what happens when people fail to plan for this possibility. It finds that even high-income retirees run out of money and need to use Medicaid to cover nursing home care.

“Medicaid… serves not just the poor, but also relatively well- off retirees impoverished by costly medical expenses,” the brief says, an outcome that has serious implications not just for these people, but for their heirs.

The eligibility rules for Medicaid are strict, with a cap of only $2,000 on what are termed “countable assets” and a five-year lookback period that essentially forces people to burn through the wealth they’ve accumulated. The government says about half of people who enter nursing homes start off paying for it themselves, but many of them spend down their assets — leaving little or nothing for their heirs — and end up on Medicaid.

The Boston College researchers looked at single seniors by income group as they aged and tracked who was covered by Medicaid. While Medicare covers all Americans once they hit the age of 65, the coverage doesn’t cover long-term care like nursing homes. For people without enough savings or who didn’t plan ahead and take out a long-term care insurance policy, the high cost of nursing homes can force even well-off seniors into poverty, at which point they’re eligible for Medicaid, which does cover nursing home care.

Although the percentage of high-income elderly who get Medicaid assistance starts out at zero when they’re 60 years old, it climbs steadily as they age, and around 20% of this population needs and qualifies for Medicaid by the time they hit their late 90s. “Higher income retirees… tend to live longer and face higher medical needs in very old age, which can result in them ending up on Medicaid,” the brief says.

Granted, many don’t live that long, but Americans are experiencing longer retirements and life spans. The CDC says the number of people 85 and older will rise from about 6 million in 2015 to almost 18 million by 2050.

“Medicaid is a safety net and it’s great that it’s there, but… you have to understand it’s likely to limit your options,” Barrington says. “If you want to leave behind any kind of legacy to your heirs or to charity, if you end up going on Medicaid, you can essentially forget about it.
A 2012 study by the Employee Benefit Research Institute found that people who lived in a nursing home for six months or more had median household wealth of only about $5,500. “For nursing home entrants, median housing wealth falls to zero within six years after the initial nursing home entry,” the study says.

“That safety net does come with strings attached,” Barrington cautions. “It’s going to sharply limit what you’re able to pass on.”

MONEY

The Supreme Court Just Saved Investors from Themselves

Many employers and employees ignore the risks of holding company stock in 401(k)s. Not for much longer.

Savvy investors already know it’s not smart to hold your employer’s stock in your 401(k) retirement plan. Wednesday’s unanimous ruling by the Supreme Court should make it harder for employers to encourage it. That’s probably a good thing.

The case, which involved Cincinnati-based bank Fifth Third FIFTH THIRD BANCORP FITB -1.4911% , revolves around whether workers can hold top brass responsible for big losses on employer stock in their retirement plans. Fifth Third, once seen as a sleepy mid-western bank, saw its stock plunge more than 70% during the financial crisis, stinging investors. The Supreme Court didn’t resolve whether or not Fifth Third—which maintains it treated 401(k) savers and its other investors appropriately—really shirked its responsibilities. Ultimately the case was sent back to a lower court, which will decide whether it can proceed.

Even so, the Supreme Court made an important tweak to the rules that companies need to follow when setting up their 401(k) plans, benefits lawyers say. Up till now companies used to get something of a legal free pass when they added employer stock to 401(k)s. Not anymore.

Here’s how the rules changed: Employers are required to make sure plans include only “prudent” investment options like diversified stock and bond funds. Because giving employees stock is seen as a motivational tool and a way to help workers share the wealth, however, company stock was a special exception. Now, in the wake of the Supreme Court decision, employers will potentially have to justify that their stock is prudent, perhaps by pointing to a bond rating or a healthy price-to-earnings ratio, according to Bruce Ashton, a Los Angeles-based benefits lawyer. “They’ll have to show more diligence,” he says.

The upshot, according Marcia Wagner, another prominent benefits lawyer, is that fewer employers will offer stock in their 401(k)s. “It’s risky for them now,” she says. That’s “a tectonic shift.”

Ultimately it’s good news for investors. The popularity of company stock in retirement plans has been waning for years, at least since the implosion of Enron in 2001, when the spectacle of employees losing their jobs and their savings at once became national news.

While nearly 20% of 401(k) dollars were in employer stock in 1999, according to benefits researcher EBRI, by 2012, the latest date for which data is available, that total had fallen to 7%.

Still not everyone seems to have gotten the memo. About 6% of employees have more than 90% of their 401(k)s invested in company stock, EBRI reports. Meanwhile about one in 10 employers still require 401(k) matching contributions be in stock, according to Aon Hewitt, a benefits consulting company. Maybe not for much longer.

 

MONEY retirement planning

Forget About Saving. Just Go on Vacation.

Mickey Mouse posing with the Gaither quintuplets
You budgeted for your Disney World trip, but did you count the hit to your retirement savings? Gene Duncan—AP

Americans get retirement saving backwards: We think about it more when there's less time to do it. Millennials, now's the time to fix on the problem.

More people plan for their next vacation than plan for their retirement, new research shows. This won’t shock anyone who has followed the retirement savings crisis in America—or scraped together $12,000 for a family trip to Disney World. What’s striking, though, is how totally upside down our thinking is on this issue.

The amount of time we spend thinking about retirement increases with age across every cohort, the financial services firm Edward Jones found. That makes sense until you think about it. By the time you are in your 60s it may be too late to make much of a difference in your nest egg. A little more thinking in your 30s would go a long way.

Yet Jones found that time spent thinking ahead about retirement rises dramatically with age. Among those 18 to 34, only 9% say retirement planning is top of mind. The share rises to 31% among those 35 to 44, to 37% among those 45 to 54, and to 40% among those 55 to 64. Overall, Jones found that 28% of Americans have the next vacation top of mind while 25% have retirement planning and 22% have paying for college top of mind.

Once upon a time, retirement planning could wait. More workers had pensions and retiree health benefits. Planning was more about when to take Social Security, who to designate as beneficiaries, and how to trigger pension payments. Today, if you don’t start thinking about retirement before 55 you are either wealthy or out of luck. Yes, important adjustments can be made at any age—like taking advantage of catch-up tax-deferred savings rules, working longer and delaying Social Security benefits. But the real juice is in saving early and often.

Compound growth for an extra 20 years, or even just 10, can more than double your savings over 35 years. Investing $2,000 a month and earning an 8% return would provide $399,082 over 35 years, according to data from T. Rowe Price. Savings after 25 years would total $165,457; over 15 years, just $60,203.

So when only 9% of young adults say that retirement planning is top of mind, it means that 91% are at extra risk of falling short in the long term—and doomed to think about retirement finances much more often when there is much less they can do about it.

MONEY Financial Planning

A Money Lesson from My 8-Year-Old Daughter

Girl removing nail polish
Inti St Clair—Getty Images

A financial planner reflects on what her daughter has already learned about money — and what her clients need to learn.

I’m a financial planner. I’m also the mother of an eight-year-old girl. My work and my family are two different parts of my life, but they have something in common: Whether I’m with my clients or my daughter, I’m always conscious of financial lessons that I want to teach — and I’m always wondering whether those lessons will sink in.

That’s why I want to share a moment I had with my daughter in April. As a treat, we visited New York City over her school’s spring break. We were in Times Square, inside one of her favorite stores in the world, Toys ‘R’ Us, and she was trying to decide how to spend some of her money.

She spent some time watching a demonstration of a fingernail design set — one she could use to paint and draw on her nails. The more she watched, the more I was sure that my young fashion diva would be enticed into buying the design kit. Finally, she asked the price. It was more than $20.

“I am not spending my money on that!” my daughter cried.

Her declaration was music to my ears. It wasn’t because I didn’t want her to spend any money; it was because she had demonstrated that she was thinking about how she wanted to spend her money — and how she didn’t want to.

So maybe some of her money lessons had sunk in. On our daughter’s eighth birthday, my husband and I had opened a checking account for her as the culminating event of the celebration. She was thrilled by the idea of knowing how much money belonged to her. Since she was an exceptional purse-carrying math student, the timing was right to put her skills to work.

My husband and I set the money rules. As she received gifts, we decided what amount should be shared (as charity), saved (for college), and spent (consumption). Over the following months, she consulted us on each of her purchases, gathering data before buying.

It didn’t take long for her to realize that the money left her account more rapidly than it was added to her balance. This dilemma created two necessities: (1) careful consideration of what and when to buy (so long, instant gratification!); and (2) creative thinking about replacing and growing her funds.

Many adults struggle with the same money lessons that our daughter is facing. Turning income into wealth while enjoying life is a balancing act with many twists and turns along the way. Keeping your balance requires a clear vision of goals and values, the diligent use of resources, and an acceptance of the relationship between time and money.

As a financial planner, I see a few key indicators of how well adults have applied these money lessons to their lives:

  • Is their lifestyle sustainable? A client’s spending plan and personal balance sheet offer insights into the client’s use of income to build wealth. I have new clients do a “money rhythm” exercise: They fill out a calendar showing when income arrives each month, and how much they receive; they also note the timing and amount of their regularly recurring expenses, such as the rent or their mortgage payment. This gives me a quick picture of their situation, and helps me see whether any cash-flow problems stem more from their core expenses or from discretionary spending.
  • Are they maximizing financial strategies? Securing appropriate insurance and engaging appropriate tax, estate, investment, and retirement strategies will help to protect and grow a client’s hard-earned income and accumulated wealth. For me, the sign that new clients are on the right track is that they’re aware of benefits offered to them in the workplace and are taking advantage of them. People who have come from a background where they are exposed to such issues have often gone beyond that. Other people just have their head in the sand.
  • How do they balance time and money? The earlier that clients start saving, the more lifestyle and career options that are available to them. For me, the key indicator of whether people understand this is emergency savings. A young adult may have a lot of student debt, but if he or she has $5,000 in the bank — maybe a month or two of funds — it’s a sign that he or she knows the importance of having a floor of safety.

I wonder if my third grader knows just how valuable it is to have learned what she already knows about money. I do.

————————————–

Lazetta Rainey Braxton is a certified financial planner and CEO of Financial Fountains. She assists individuals, families, and institutions with achieving financial well-being and contributing to the common good through financial planning and investment management services. She serves as president of the Association of African American Financial Advisors. Braxton holds an MBA in finance and entrepreneurship from the Wake Forest University Babcock Graduate School of Management and a BS in finance and international business from the University of Virginia.

TIME Money

Americans Still Aren’t Saving for a Rainy Day

Lesson from the recession not learned

+ READ ARTICLE

Families in the U.S. still don’t have a substantial amount of cash tucked away for a rainy day despite the beating the economy took in the Great Recession, according to a new survey.

The Financial Security Index from Bankrate.com shows half of American families have no savings or less than three month’s worth of expenses saved for emergencies. The survey’s findings, analysts note, haven’t changed since 2011, when the company first began inquiring about the saving habits of American families.

“Americans continue to show a stunning lack of progress in accumulating sufficient emergency savings,” said Greg McBride, Bankrate’s chief financial analyst.

Analysts say the recession—during which Americans lost about $16.4 trillion in household wealth by 2011—should have been a learning experience, but the struggle of juggling household expenses has left many without extra funds to put away.

Not all Americans are failing to save. About 23% of those surveyed have savings that will last them six months or more in case of a financial emergency—the recommended stash amount. What’s more, the majority of those saving big have larger incomes, though only about 46% of those making $75,000 or more have over six months worth of expenses stored away.

The website notes that while three to six months worth of savings may sound like a lot, starting small and increasing the amount being put away over time can pay off quickly.

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