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How Much Longer Can This Continue?
February 2006
The government recently reported that Americans spent more than they earned in 2005, resulting in an annual negative rate of saving for the first time since 1933 during the Great Depression.
Couple this finding with two other increasing concerns:
- Baby boomers are increasingly coming to the realization that they need to work in retirement to make ends meet, and
- The younger generation needs to start saving more due to the frailty of Social Security and the demise of company-provided defined benefit pension plans.
Economists studying this phenomon noted that excess spending has been facilitated through tapping home equity by refinancing and the use of home equity lines of credit. Americans feel richer since the value of their homes have been rising and increasing their net worth. A second "feel-good" that consumers have is the recent performance of the stock market, which has generally increased the values of their investment portfolios.
Does this mean that a family comes out the same if they save $20,000 or if they save nothing but the values of both their home and their investment portfolio each increase by $10,000? Surely, the increase in the family's net worth is the same; however, here are some interesting differences to think about:
- Spending and saving are life-long habits. When a family saves money, this tends to hold down their standard of living costs. The lower the standard of living that keeps your family happy, the lower your living costs will be during retirement. This better positions you to successfully fullfill your retirement living needs from your retirement income sources.
- Families experiencing (or counting on) a run-up in their investment balances mostly through investment returns can be expected to be more fully committed to the stock market and subject to market risk. Future markets may not continue to be investor friendly as we saw during the years 2000, 2001, and 2002. For some of us, increasing our portfolio balance by $10,000 is less risky if we do so by saving an additional $5,000 and investing more conservatively so that our portfolio needs to earn only $5,000 instead of $10,000 during the year.
- Hearing that the value of our home increased $10,000 makes us feel good. We feel richer, and the banks will loan us $10,000 more to continue expanding our lifestyles. While our net worth has gone up by $10,000, this increase to our net worth from a retirement standpoint should only be counted if we ultimately can sell our homes, reduce our residential living costs and convert the difference for use as a retirment income source. What do you think will happen to market values as large percentages of baby boomers try to sell and downsize their larger homes at about the same time?
How much longer can this continue? My bets are, not much longer!
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