Tag Archives: savings

Retirement, Savings, and your Nest Egg

Americans, both young and old, ought to be concerned about saving for retirement.  For older people, retirement is drawing near, and thus they don’t have very much more time to save before they decide to retire.  Their last few years before retirement can be the difference between financial security, and running out of money in retirement.  One of the biggest problems in planning for retirement is that as Burton Malkiel suggests in “Random Walk”, perhaps the vast majority of advice about retirement is either bad, incorrect, or bias.  Although there is a lot of debate about how a retiree should allocate their assets in retirement to stocks and bonds, there is no debate about this: people need to save more.  In this post I will very briefly review what Malkiel has to say, along with other good sources, then give what my retirement strategy will be, and finally return to the woefully state of American retirement planning.

As Professor Kimball stated in class, and the above WSJ article state, investing should start early and risky.  Almost all analysts believe that since younger people don’t have to worry about their portfolio running out during a bear market they can tolerate more risk in a portfolio.  Over time, this will bring in higher returns, which over time can make an enormous difference.  As people get older, they should put more weight into safe assets, like bonds; one rule of thumb is one percent weight for your age.  Depending on income levels, you should invest in an IRA and 401(k) to avoid taxes, and thus maximize your profits.

As it stands, my investment strategy will be this:

  1. Start Early: As soon as I graduate, and have a stable job, I will contribute as much into an employer matched 401(k) plan as possible.  An employer matching your 401(k) will help me in two ways.  First, I get free money, and second that free money will incentivize me to save rather than spend my money
  2. Put Equity in the things I Own: Unlike many college graduates, I want to begin investing in a home as soon as is feasible.  Although more financially straining at first than renting an apartment, immediately putting money into a home will save me thousands (or perhaps tens of thousands) of dollars by not gaining any equity from an apartment, and also from the appreciation of home prices.  I never plan on leasing or buying a new car in my life.  I don’t really care very much about having a new car, and I will save thousands over the course of a lifetime.
  3. Do my research:  Unsurprisingly, seeing as I am writing this now, I will be careful about the investments I make.  I plan on following the advice of the adherents of the efficient market hypothesis (like Malkiel), and invest primarily in index funds to achieve stable returns.  As both Professor Kimball and Malkiel suggest, I will stay away from funds that take an unreasonably high commission.  Even .1% or .2% when compounded for decade can add up to thousands of dollars.  I plan on investing in an IRA to defer my taxes to a lower tax bracket later in life.
  4. Be prepared: This is a small step, but I will probably keep a small amount of money (a few months worth) in case of an emergency situation, loss of a job, etc.

The unfortunate truth is that unlike myself, and probably many of you, many older Americans have planned little have saved less, or even nothing for retirement, whether out of necessity, arrogance, or ignorance.  According to recent research, the typical home of a 65-68 year old, “had very little savings, no defined-benefit pension plan (one that pays a set sum each month) and only about $5,000 in a defined-contribution plan (such as a 401k) or Individual Retirement Account. Their retirement basically relies on Social Security and the equity in their homes.”  I only hope that we, as a class, and as a generation, do a better job than the generation before us. 

QE May Be America’s Friend, but It’s Not Mine

After the Great Recession, the Fed began the use of Quantitative Easing (QE) in an attempt to put the economy back on track.  With short-term interest rates already near zero, the Fed began purchasing unconventional, longer-term assets in order to bring down long-term interest rates.  And much of the world followed suit.  Since the Great Recession, the Federal Reserve, ECB, Bank of England, and Bank of Japan have injected more than $4 trillion of additional liquidity into the world economy.  Looking at the results of this “easy money” policy, QE seems to have been beneficial.  Indeed, more QE, coupled with the elimination of the Zero-Lower-Bound, would likely have made America’s long economic recovery much faster and much less painful.

According to a study by McKinsey, low interest rates brought about by QE have saved the federal governments of the USA and European countries over $1.6 trillion since 2007.  This savings on debt-interest payments has allowed governments to achieve higher levels of spending and reduced levels of economic austerity (at least in some places).  The private sector has also benefited, with non-financial corporations saving over $700 billion in interest payments in the last five years.  This savings has helped boost profits for US corporations over 5% in a time when the economy was struggling, helping to contribute to a reduced unemployment rate (even though this recovery has been very slow and painful).

Nevertheless, as is commonplace in economics, what benefits the greater economy does not usually benefit individuals.  Take a recession, for example.  During an economic downturn, individuals benefit from increased savings.  Increased savings allows individuals to tolerate a slump better, ensuring adequate income at a time of economic uncertainty.  Increased savings, however, is bad for the economy.  The aggregate economy requires increased levels of spending to boost aggregate demand and help pull the economy out of its slump.  In this way, we can see that the micro-level and macro-level goals do not necessarily align in economics.

Unfortunately, this goal divergence applies to QE as well.  I have already pointed out that QE greatly benefited the aggregate economy by lowering interest rates and making it easier for governments and corporations to spend.  For individuals, however, these low interest rates have had a devastating effect.  Most notably, low interest rates have wreaked havoc on the cash flows of retired, fixed-income investors.  Indeed, household in the USA and EU have lost over $600 billion in net interest income since the introduction of QE.  For those in retirement relying on cash payments from interest-bearing assets, this typically means a reduction in income and a reduced quality of retirement.

In this way, it seems that QE has benefited the aggregate economy at the expense of individuals.  It is true that those relying on increased wages have benefited from QE as unemployment falls.  But more senior individuals, who rely on fixed-income assets as their main source of cash, have greatly suffered from lower interest rates.  I do not mean to say that QE is a bad policy.  Indeed, I believe QE, like negative interest rates, is a necessary policy to help control our bleeding economy’s pain.  But the effect of QE on individuals points out that in economics, there is rarely a win-win situation.  Whether it is QE, taxation, subsidies, trade barriers, or any other type of economic policy, there is almost always a loser.

Lack of Americans Saving money during recover

The Wall Street Journal just released an article today about how the US public is saving less.  According to the article, “1 out of 3 Americans aren’t saving any money”.  Since 2010, the savings rate has dropped from 73% to 68%.  The article seems to paint a picture that this is a bad thing that the US public isn’t saving as much as they were at the time the recession hit.  It does make the point that only 69% of households making less than $50,000 are able to save compared to 80%.  This statistic does seem to illustrate how the income gap will likely keep going, but I wonder if the drop in savings is actually that big of a deal.  As mentioned in class, the goal during a recession is to get consumers to save less and spend more.  It seems that the Fed has been successful in reducing savings and increasing spending by lowering the interest rates.  The savings rate has fallen from 5.8% in December of 2010, to 3.8% in December of 2012.  The article, written by Jeffrey Sparshott, mentions how some groups are trying to encourage consumers to increase savings.  The whole article implies that the decrease in savings is a bad thing, when we have learned recently in class, spending is what helps an economy recover from a recession, not increased savings.  It would appear that Bernanke’s low interest rate policy has in fact increased consumers consumption.

The question now shifts to how Yellen will build off of the success that Bernanke had.  According to policy makers, “Policy makers plan to abandon their promise to hold interest rates near zero at least as long as unemployment remains above 6.5 percent, according to minutes of their January meeting. With the jobless rate dropping to 6.6 percent and the economy still in need of support from the Fed, the strategy is almost obsolete.”  Unfortunately, this is more difficult than expected.  The Fed needs to figure out how to shift away from the unemployment threshold of 6.5% without letting the public believe they are increasing interest rates.  The belief is that the Fed will begin to place more emphasis on the “Summary of Economic Projections”, otherwise known as the SEP, to signal their intent.  This means a shift to relying on the Fed’s forecasts of inflation, unemployment rate, growth and benchmark interest rate to signal their policy goals.  It will be interesting to see if Yellen continues to spur spending like her predecessor Bernanke did.

Gradual Increase in Consumer Spending.

Subjects of my past few posts were regarding the FOMC’s announcements and the global reaction it received. FOMC’s decision could be characterized by their belief that the US economy is on track in recovering and needs less help from the Fed. According to a news article in Bloomberg, US consumer spending has indeed increased. In January 2014, the consumer spending rose 0.4% and 0.6% in the previous month, contrary to economists’ expectation of 0.2% for both months. However, the average income was largely undeterred from previous level (less than 0.1%). What does all this mean?

I think US economy is really picking up its pace as Fed has expected. Fed’s annual target Personal Consumption Expenditure (PCE) index is at about 2~2.5%. Although 2013’s annual rate staggered around 1.1%, in december alone, there was a 2.5% hike and january consumer spending is still breaking economists’ expectation upwards.

Nonetheless, I still have few thoughts on what this actually might mean. One of my concern is employment. I have already mentioned that the average income stayed more or less the same, but average income being the same, the natural course has that the savings rate must be dropping. In the short term, consumer spending may be more relevant in driving the economy, but in the long term, having an appropriate level of savings rate may be more sustainable. Economies that enjoyed rapid expansion all had very high savings rate to support investments. China for example had a savings rate swooping around 30% at one point, funding much of investments for future growth. US savings rate is around 4% in recent years, and even the highest times never broke above 20%. Arguably, US is a more mature economy if not the most mature economies in the world for that matter, but with household debt level increasing, I actually don’t think it is a bad idea to start saving.

Regardless of the savings rate, I think the employment issue should be addressed. In January 2013, the unemployment rate lingered around 8% according to the Department of Labor. One year later, we see a greater improvement with unemployment rate around 6.7%. Like we discussed during class, high unemployment rate should be the one most feared factor. It is evident that this is stabilizing. I think further employment would raise the national average income level to a certain degree in which case higher consumption is not too much of a concern.

Overall, I see consumer spending rise as a positive sign. Consumer confidence level still in the rise, and constant demand for many luxury goods even in the events of hard times, I could only assume that US recovery is on the right track.