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Saving and Investing: Two Different Disciplines

Saving
Often saving and investing are lumped into the same category in terms of financial disciplines; however, my opinion is that these two efforts are very different undertakings and it is important to recognize the differences. The fact that the United States has one of the lowest household savings rates of any of the industrialized countries, and far lower than several of the so called “developing economies,” is ample reason to focus on this topic. In many cultures, the art of saving is learned by children, just as they learn to walk and talk and dress themselves. It is instilled into their daily lives by virtue of cultural efficiencies which decry waste of any resources, and encourage and eventually reward thrift and conservation. Japanese households currently save in excess of 20% of income; Indian households save in excess of 30%! We have a long way to go.

Why is saving so critical? Let’s look at the numbers.

The chart above covers 50 years of savings rates for American households. We can see that during the late 50’s and through the mid 80’s Americans saved 8-12% of their household incomes. If we did a deeper analysis, we would see that the increases and decreases in savings rates did correlate to changes in Federal income tax rates somewhat; that is to say that when taxes were lower we saved a bit more. However, that relationship between lower taxes and higher savings was shattered as we passed through the mid 80’s. Savings rates declined precipitously for two decades during which we enjoyed numerous Federal income tax decreases. The 80’s have been called the “decade of consumption,” a description which remained appropriate for the 90’s as well. Not much changed through 2006, when we experienced a negative savings rate for the first time since 1929. (See above chart) However, as we hit the turbulent economic times in the last quarter of 2008 we saw a spike in savings rates back up to the 5% level. Hopefully, this trend will continue.

With the concurrent rise in consumer debt over the last two decades (primarily credit card debt), we have evidence that not only were we poor savers, but also we spent beyond our means. The relationship between savings and investing is critical, because if we fail to save, we have no means with which to invest. There have been some efforts in both private and public schools to encourage teaching the art of saving to children at the earliest ages. These efforts have been too few to truly benefit our economy as a whole. In a recent article published on the BCU web site, I discussed the concept of “paying yourself first.” It has been my experience that the only successful savings plans have been those which include a specified amount (either a dollar amount or a percentage of income) to be put away each pay period or each month. It is this systematic and repetitive effort that leads to successful saving. If we could change only one of our perspectives on consumption, in my opinion it should be that we set a goal to save a substantial amount toward any large purchase before the purchase is made.

There is nothing wrong with borrowing for major purchases; in fact responsible borrowing plays an important role in a long term personal financial plan. However, if we first saved a substantial amount toward any large purchase, we lessen the burden upon ourselves in servicing the debt that we do undertake. One outstanding example of irresponsible borrowing that will haunt our economic health for years to come is the mortgage debt problem. In the last ten years, many people had little or no savings to use toward a down payment on their home purchase; consequently, as home values have fallen they find that they owe more on their mortgages than the value of their homes. Conversely, many who had saved substantial down payments of 20 – 25% of the purchase price of their homes find themselves in much better financial health today.

In summary, saving is the art of building a strong foundation to our personal financial structure; it is learning the discipline to control spending in order to allow for money to be set aside for future needs. How much we save is important, but not as important as how systematically we save.

Investing
I view investing as putting savings to work. While savings takes discipline to allocate a portion of all income to provide for the future, investing takes time and effort to educate ourselves about the various alternatives available to us. If we look at it logically, investing can be viewed as

  • Saving in order to invest
  • Setting our financial goals, for example, retirement, home ownership, college education, other major purchase
  • Define our objective(s)
       1. safety
       2. growth
       3. income
  • Educate ourselves on the investments which match our objective(s), for example individual stocks, mutual funds, credit union CD’s, corporate bonds, government bonds, municipal bonds
  • Understand the risk/reward ratio: the greater the risk, the higher the expected return on investment
  • Allocate our savings to those investments which meet our objectives
  • Monitor performance and make adjustments
  • How much do I need to get started investing? The answer depends on the type of investment product(s) you select. I have taught my children to accumulate $500 in savings and then to purchase a credit union certificate of deposit (CD) with the $500. CD’s generally pay a better rate of return than a savings account. Eventually multiple CD’s can be combined to achieve even higher rates, or to use for a different investment such as the purchase of mutual funds. The investments we choose need to correlate to our objective, whether our objective is safety, growth or income. Generally, the return on any investment is related to the risk of that investment: higher risk investments should achieve greater returns.

    As we entered these troubled economic times, many people placed their investments in US government bonds because “safety” became their primary objective. Government bonds are considered the safest (least risky) of all investments, and therefore the return is correspondingly lower.

    Investors whose goal is to save for retirement, and who have many years to achieve that goal, may choose higher risk oriented mutual funds because “growth” is their objective. Growth funds involve greater risk because they contain shares of newly emerging companies with unproven track records, therefore the expected returns should be correspondingly higher. Eventually, as we retire, either voluntarily or involuntarily, our focus may become “income.” Our investment selections could include a mix of corporate bonds, government bonds, CD’s, and dividend paying high quality stocks. These types of investments, while they still involve risk, pay fixed amounts of return allowing the investor to budget expenses accordingly.

    Monitoring our investments and making adjustments is essential in today’s ever changing economic climate. Many have learned how to “buy” a stock or a mutual fund, etc., but very few have learned when to “sell.” In my opinion the “buy and hold” approach was never a good strategy, and in today’s market it could actually be fatal. General Motors, Chrysler, General Electric, AIG, and many more “top” companies have fallen upon very bad times, and their investors have not escaped the fallout. Today’s economic climate warrants an ongoing vigilance over all of our investments, and it requires making changes to our portfolios that capture the successes and eliminate the failures. All of these efforts can be accomplished through our own due diligence and with some professional help such as the BCU Investment Advisors group or our own personal financial planner; as with our physical health it is always valuable to get a second opinion on our financial health.

    ©Patrick J. Catania 2009
    The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances.

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