I came across one of the single best explanations for the average, new investor as to why the personal "savings rate" that you hear so much about is totally meaningless. The way the United States Government calculates personal savings ignores all retirement income and capital gains, among other criticisms:
The so-called personal saving rate is a highly misleading indicator of the consumer balance sheet. Other, much better measures show that the American consumer is in excellent financial health.
To calculate the personal saving rate, government statisticians subtract taxes and spending from personal income. Income includes wages, salaries, interest, dividends, rent received, small-business profits, and some government benefits. Excluded are withdrawals from IRAs and 401ks, as well as capital gains. This is inconsistent with how most people measure their private fiscal health.
For example, a retiree with no wage (or other) income, who withdraws $40,000 each year from her IRA to spend on living expenses, would drag down the savings rate. Or, as Bear Stearns economist David Malpass pointed out, the $30 billion in appreciated Berkshire Hathaway stock Warren Buffett has pledged to the Gates Foundation was never counted as income. But when that money eventually gets spent it will count as consumption and reduce "personal saving."
A basic problem with the often quoted personal saving rate is that it mixes together current workers with retirees who should be expected to spend much more than they earn. One academic economist has calculated that excluding retirees from the figures would add about 4 percentage points to the saving rate. Moreover, this error should grow over time as the US ages and healthcare costs (a major purchase for retirees) continue to grow.
Another problem with the saving rate is that when consumers buy durables - think cars, furniture and appliances - the spending is counted right away even though payments will be made over time. Amortizing these purchases would push up the saving rate another 2 percentage points. Interestingly, despite this treatment of durable goods, the government does subtract housing depreciation from income. And because home prices have climbed dramatically in recent years, depreciation has climbed. In 2006, this depreciation subtracted $226 billion from saving - it did not affect consumer cash flows, but pushed the "official" saving rate into negative territory.
In the end the saving rate, as it is currently calculated is a useless measure of household balance sheets. A much better measure of true savings is the net worth of households, a statistic calculated by the Federal Reserve. As of September 2006 (the latest data available) US households had $54 trillion more in assets than liabilities, an all-time high. Moreover, total net worth had increased by $3.5 trillion from the year before. If this $3.5 trillion increase in net worth were used as the appropriate measure of personal saving, the saving rate was 37% last year and has averaged 33% the past ten years, a far cry from the "negative saving rate" which so many pessimists decry.
I was just looking for the method the US uses to calculate the savings rate and found this. This analysis seems so obvious that I wonder why I’ve not seen it or any thing like it before. I was looking for the savings rate calculation for just such an analysis. The savings rate is so obviously misleading I wanted to make some notes to and think through how and why. I’ll have to think on this some more, but this makes sense and will be a great help.
I just looked at the citation and see it is from Feb. 2007. I’ll be looking to see if anyone else has written on this.
Flech
Fletch, most people don’t even pay attention to it. That is why I find it hard not to roll my eyes when financial “journalists” bemoan the “negative” savings rates of most Americans. It’s like saying the calories from cupcakes don’t count if you eat them after dark or rounding Pi to 3.
This article was written in June 2010, yet claims that “…because home prices have climbed dramatically in recent years, depreciation has climbed.”
I would like to know what part of the country has experienced dramatic increases in home values in the last 5 years or so? Perhaps he is speaking of a much longer time frame when he says “recent years?”
I have been in financial services for over 10 years. I can absolutely guarantee that the personal savings rate has NOT averaged 33% in the last 10 years. Merely suggesting that is beyond absurd. If households were businesses, the average home would be somewhere about breaking even.
I’m not saying the government’s definition is perfect, but this conclusion is laughable.
The article was written at the end of 2006 and published at the beginning of 2007 shortly after the peak of the housing bubble. You are looking at the “updated” date for the blog, not the original quote from Time Magazine.
The original author used average, not median, savings rates. The rich, who control a vast majority of the country’s resources, reinvest most of their earnings. The example of Warren Buffett is useful. Before beginning his charitable donations, Buffett took no dividends from the tens of billions of dollars in profit generated by Berkshire Hathaway. You put him in a room with 100,000 middle or lower class people and the “average” savings rate is going to be enormous even if everyone else is going into debt. The median savings rate, which isn’t discussed, would show a much different picture.
As a professional, you should know the difference between mean and median. That is freshman statistics 101. Looking at the period of 1996 to 2006, the figures in the article are accurate since it is talking about the United States on a macroeconomic basis.
To summarize, you are making three significant errors in judgment:
1. You don’t have the publication date right. It would have taken a few seconds to click through and check. The period discussed is 1996-2006.
2. The article discusses “average”, or mean economic savings rates yet you don’t seem to understand the difference between that and median savings rates
3. The article discusses macroeconomic savings levels for the nation as a whole, yet you are discussing microeconomic implications for individual households. The article isn’t discussing that; it is criticizing the methodology of a government sponsored metric to measure the net accumulation or deficit of savings from a top-down basis.
The article, which appeared on Time’s blog, does contain an error in that the author does not apparently know the difference between simple interest and compounded growth rates, which I consider a significant oversight. But the proposed solution is closer to economic reality for the nation as a whole than the current paradigm. Your mistake is somehow thinking that is relevant to individual families. That isn’t what we are discussing.