Tuesday, June 23, 2009

The economy is not likely to have as robust a recovery as economists' current consensus view. This means that repair of personal balance sheets will take longer than any of us would like. With a more modest recovery, the self-fulfilling slow-recovery result is that it is wise for individual buyers to remain conservative in their spending and savings practices.

In fact, that is what is happening. According to the U.S. Commerce Department, personal savings as a percentage of disposable income rose to a 14-year high of 5.7 percent in April 2009. By comparison, the U.S. savings rate was near zero around a year ago, and was negative for a portion of 2005. The "problem" with those relatively high current savings rates is that the economic recovery would be assisted by a return of the spendthrift foolish days that preceded the current recession. Putting aside our collective interest in having a strong economy, this is a good time to set aside money for your retirement, and not count on a resurgent economy to address your long-term needs. Here are reasons why most Americans need to be saving more:

1. The current savings rate, while large by recent standards, is not large by historical standards. From 1960 through around 1985, the savings rate was in a band of around 8 to 12%. The current savings rate could double from its current 14-year high, and still be just normal based on a longer view of financial history.

2. America's affluent are leading these new savings rates. According to an April 29, 2009 "Survey of Affluence and Wealth in America" by American Express Publishing and the Harrison Group, the affluent (i) are pessimistic about the U.S economic recovery, (ii) are saving dramatically more than previously, and (iii) are happy with their desire to rebuild their wealth by not spending. Like it or not, according to this same study, those making more than $100,000 a year are responsible for half of retail sales, and 70 percent of retail profit margins. Consequently, having these people save more really does affect the economy.

Economic theory, together with the 2008 annual survey of the affluent by Ipsos Mendelsohn, tell us that much of this pessimism is caused by the announced additional taxation that the Obama administration plans to impose on this portion of our population. According to Ipsos Mendelsohn, taxes have become a major concern to now-cautious high-income earners. Consistent with the American Express survey discussed in the preceding paragraph, this survey also found that the affluent are now enjoying a more thrifty mentality. Unless the Obama administration changes its taxation plans and related rhetoric about how these people do not deserve what they have (something this author does not expect), the affluent will remain grumpy and less motivated to earn and spend.

3. More modest American households are also in a defensive mood because the recession (at least so far) destroyed at least a third of their real estate and financial asset wealth. Although moderate-income consumers are now deleveraging, their accumulated wealth plummeted much faster than debt repayments. The deleveraging process is going to take decades, not months or years.

4. Those who are under 50 years old and are intelligently planning for their retirement no longer include Medicare and Social Security in their plans. The only way to replace these government entitlements in retirement planning is to start retirement with a larger nest egg. To understand why these government programs are not to be trusted, one merely needs to read what the U.S government has said in both the fiscal 2007 and 2008 "The Citizen's Guide to the Financial Report of the United States Government". The following is from the most recent report:

"If the Government is to retain the ability to manage a financial crisis such as the one today, it must eventually address the long-term fiscal imbalance resulting from Social Security, Medicare, and Medicaid. The Government's fiscal policies for these programs as currently structured are not sustainable. Without changes, spending for Social Security, Medicare, and Medicaid would permanently and dramatically increase the Government's budget deficit and debt, leading eventually to renewed financial and economic instability…

An Unsustainable Fiscal Path - The projected growth in entitlement spending under current law – chiefly for Social Security, Medicare, and Medicaid – will ultimately affect every citizen in the nation. Continued growth in health care costs is expected to cause government spending for its major health programs to grow faster than both the economy and Federal revenues over the next 75 years. Similarly, population aging is expected to cause the Government's Social Security and health program costs and expenditures to increase as a share of GDP over that period. Consequently, total Government expenditures are projected to exceed total assumed revenue throughout the projection period, with the fiscal imbalance – between spending and revenue – growing larger each year into the future.

… large and growing deficits could increase Government debt levels as a percentage of GDP to unprecedented and unsustainable heights – from 170 percent by 2040 to over 600 percent by 2080 – far exceeding the historical high of 109 percent that occurred immediately following WWII and far exceeding the Government's ability to fund program expenditures."

5. Federal spending next year will reach 28 percent of gross domestic product. Federal spending has exceeded 25 percent of GDP only four times in U.S. history, and never recently. This increased federal spending is deficit financed, which is a fancy way of saying that the federal government is simply printing more money. According to statistics compiled from federal government sources, the federal government currently has liabilities and unfunded obligations totaling over $56 trillion, which is equal to $483,000 for every American household. The only time the federal debt as a percentage of U.S gross domestic product was higher occurred immediately after World War II. Then, the high debt was repaid to below current levels within the decade after the War.

To make matters worse, foreign governments and non-U.S citizens currently hold around half of all federal government debt, making the U.S. ultimately beholding to those outside our borders. In 1990 by comparison, foreign holders owned less than 20% of U.S. debt. The U.S.'s ability to proceed with current government policy, as well as to simply refinance the mass of existing debt as it matures, is entirely dependent on how credit worthy these outsiders view the U.S.

Inflation is the inevitable result of the monetary and fiscal economic policies that the federal government is using to combat the current recession. Inflation is the enemy of retirees, since expenses increase faster than the fixed rate income sources that are typical of retirees. The only resolution is to either start with more savings, or successfully get a higher return by accepting greater risk than is generally desired.

Those that will be hurt the most by this are those who are not saving for retirement. According to the third Real Life Retirement Survey by Charles Schwab:

1. Almost forty percent of Americans are not saving for retirement at all.

2. Despite market losses, sixty percent to the Americans who are saving have not altered their thinking about at what age they will retire.

3. Survey respondents have, on average, saved less than 20% of what they acknowledge they will need in retirement. The lack of preparedness is not limited to young people, as those age 55 to 63 have on average just a quarter of what they acknowledge is needed for retirement.

The Schwab survey concludes that Americans need a reality check on what they can actually accomplish in terms of when they can afford to retire, and as to the level of comfort and security that will exist. Greater savings are needed to avoid what will otherwise be inevitable results.

Here are some tools that will help you plan your retirement:

Article regarding How Much Retirement Savings do I Need?

Calculator showing Retirement Savings Asset Allocation

Calculator showing whether (or when) you will run out of money in retirement

Fulcrum Inquiry performs economic studies and financial investigations.