In an economy with high unemployment and falling home values, saving for an emergency fund or retirement can feel out of reach. Many consumers focus on simply making ends meet, and while some economists argue that spending can help stimulate growth, most financial experts continue to emphasize the importance of saving.
Is saving money a lost art? Recently, Bank of America Merrill Lynch studied whether Americans are saving enough. In the decades after World War II the average household saved between about 6% and 10% of after-tax income, but that rate began to decline around the mid-1980s and fell below zero in the mid-2000s as consumers used easily accessible credit to spend more than they earned.
For the most part, the average American has saved only a small share of income in recent years, and although the rate has inched up recently, many economists say it remains too low. Without a healthy nest egg, far too many retirees may outlive their money; for guidance on retirement accounts and planning see IRAs and Multi-Generational IRAs.
A mountain of debt. A lack of savings is only part of the problem; household debt relative to after-tax income has grown substantially over decades. Financial experts generally view a 100% debt-to-income (DTI) ratio as healthy. For example, if a household earns $150,000 a year and owes $200,000 in mortgages, car loans, student loans and other obligations, reducing total debt by $50,000 would move it toward a 100% DTI.
Slowly rising savings rate. Some recent data suggest the savings rate has begun to climb, and economists estimate that most households will use a large portion of new savings to pay down debt while directing a smaller share into interest-earning investments. For more on how savings, investments and emergency funds interact with broader personal finance issues, see Insurance & Personal Finance: Investments, Emergency Funds, Business and Insurer Risk.
Based on research by Federal Reserve economists, a substantially higher savings rate would be required for households to return debt levels to historically normal ranges, and such a shift could slow economic growth in the near term.
Saving is still important. Despite debate about the macroeconomic effects of higher savings, saving remains essential for individual financial security. A solid emergency fund can cover several months of living expenses if you lose your job or face unexpected medical bills, and saving regularly is a key part of preparing for retirement.
If you need personalized guidance on balancing debt reduction, saving, and retirement planning, talk to your agent.
Frequently Asked Questions
How much should I keep in an emergency fund?
Most experts recommend keeping three to six months of living expenses in an easily accessible emergency fund.
What is a healthy debt-to-income ratio?
Financial professionals often consider a 100% total debt-to-income ratio a reasonable target, though individual circumstances vary.
Should I pay down debt or invest extra savings?
Prioritize high-interest debt first, maintain an emergency fund, and then consider investing for long-term goals.
Where can I find more information about retirement accounts and investments?
Resources about retirement accounts and investment options can help you choose strategies that match your goals and timeline.