Americans are often chided for a low savings rate. We would be better off if we saved, supposedly. Instead of taking a luxury vacation or buying a beach house, we loan money to bank or invest it in a business. They use that money productively and give us back a nice return on investment so that we can, at some point in the future, take two vacations or buy a much nicer beach house.
Consumers in the past decade or so have not behaved as though they believed this pitch. They borrowed the maximum that they could out of their home equity and went off to Europe. They spent every dime that they earned and every dime that banks would lend them. They behaved as though they believed that money invested in the stock market would be stolen by managers running the companies. They spent as though they believed beach houses and European vacations would rise in cost much faster than the stock market.
It now appears that Wall Street agrees with these folks. The yield on 5-year Treasury Inflation Protected Securities (TIPS) has gone negative (story). If you give the government $1000 today, they will give you back $900 and change in 2013. Whatever they give you back will be adjusted for domestic inflation, at the officially published rate, so in theory your spending power in 2013 will only be slightly smaller than it is today. But for the average thing that you might want to buy, you are more likely to be able to buy it right now than if you bought TIPS and waited five years.
A friend who is a professional money manager says that you should expect the yield on every form of investment to converge to LIBOR. In other words, there is no reason to believe that other investments will return more than these negative-yield TIPS. They might appear to yield more right now, but that is only because we are underestimating inflation.
Due to the decreasing marginal utility of income, i.e., that $1 spent on top of $150,000 brings less enjoyment than the same dollar spent on top of $15,000, it makes sense to save a bit for retirement. Otherwise, perhaps anyone with a steady income should party on. What if disability or death interferes with that steady income? One can buy insurance against these unlikely events and that insurance might well be cheaper than the haircut you’re going to take as an investor in TIPS or any other publicly traded instrument.
Hmm… The following post has video of people with professional jobs being treated as commodities. If thats the future, then capital has all the power. If the premise of this post is true then having capital is unwise? Can I assume that your friend was talking about risk free investments converging to the LIBOR, I can believe that, but otherwise, can’t the risk premium still help me beat inflation and save money. Also can’t this just be an inflation panic with the high price of commodities tricking us? The long term future of oil looks bleak, but we probably still have a few decades left, and if we stop burning food for fuel (barely breaking even on energy) those markets would look a lot better too.
Though the fund manager / corporate officer theft issue is real, perhaps consumers have been more influenced by the wealth effect and unrealistic expectations of asset growth. If your $200k house becomes a $400k house in 3 years, then it will probably go to $800k in another 3 years, so why not enjoy a little of it now? Not to mention those gains were tax-free upon sale and HELOC interest was tax-deductible, so this several engineer-salaries of appreciation was also tax-free.
The other side of the wealth effect has traditionally been described as “keeping up with the Joneses.” Even people who aren’t explicitly trying to “keep up” with anyone are influenced by those around them. I have often felt somewhat awkward in conversations about European travel with university students because, lacking parental funding, I had not felt that I had the level of disposable income in my 20’s to go to Europe.
Thinking of all the bailout proposals, I feel like the Fed, Treasury, and the rest of the government are doing their best to help “homeowners” and therefore ensure that I will never be able to afford housing (especially housing in an attractive city).
Hi Philip,
We met at Hackers and talked about early retirement. I’m now blogging about financial freedom as well.
I think your scenario above only works if you really want to work the rest of your life. I agree with you that the government makes it nearly impossible for “savers” (not investors) to get ahead. However, my financial goal has always been to live off my investments so that I could take any job I wanted and the income wouldn’t matter. I think this is your ideal vision, too, at least according to what we were talking about at Hackers.
The real problem with a steady income isn’t disability or death (which is why those have insurance.) It’s boredom, inflexibility, and being unable to just leave if the company you’re working for goes downhill or if you wake up one day and say, “You know, I really want to be a pilot instead.” 😛 Financial freedom allows you to spontaneously leave a job you don’t love.
But you’re right to point out that saving alone won’t get you there; you have to either save enough money that 3% in a savings account will cover all your expenses (tough to do), or learn how to become a savvy investor (easier.) It’s true that both of these take effort, but if the cost of not doing them is being shackled to a job to the rest of my life, I’ll learn about investing!
-Erica
Pretty compelling argument, I for one have never been a fan of using banks for savings, especially since saving’s interest rates dropped well below inflation. The question becomes whether buying things such as second homes is spending money or investing. My experience is that the second home performed as well as or better than the stock market of the last few years as an investment, this includes accounting for the last 2 year’s real estate downturn.
This particular economic cycle is shaping up to be a nasty one, exasperated by greedy people behaving badly and 20 years of no energy policy coming home to roost. I believe, in the end, saving for a rainy day is still the strategy that will make the difference between a comfortable retirement for most versus trying to exist on social security alone.