Markets are risky and life is uncertain. Most of us will have financial good fortune at some point in our lives, and some setbacks too. The best we can do, then, is save when times are good so we can survive when times are bad.
The thing is, most Americans appear to follow the opposite advice, spending in good times and saving in bad. In December, the US personal saving rate fell to 2.4% of disposable income, the lowest level since 2007, which itself was low by historical standards.
The booming economy is credited for the increased spending. GDP continues to grow at a steady pace, there is finally some wage growth reaching the middle class, the stock market is soaring, and tax cuts are expected to provide a short-term boost. Persistently low interest rates offers little incentive to save—at least in low-risk assets. Given all these factors, it’s no wonder households are emptying their wallets and setting less money aside.
But saving is all about preparing for the unexpected. The economy may be booming now, but there are plenty of reasons to be skeptical it will last. Productivity numbers don’t justify the headline growth figures. Many people think the stock market is overvalued and due for a correction. It has been eight and a half years since the last recession, and the natural oscillation of the business cycle suggests we may be due for another one soon. Low saving rates are often seen before a recession.
The good news is households are not as insecure as they were in 2007, before the last recession. Household debt is increasing, but as a share of income, it remains well below its pre-crisis levels.
Lower debt levels suggest that even if there is a recession, accompanied by lost jobs and lower stock markets, the effects won’t be as severe as in 2008. There are still plenty of reasons to be worried. If interest rates increase, so will debt payments. And Americans may need to save more than before, because they bear more risk. Based on recent research of Social Security income records (pdf), Americans now face bigger declines in income during recessions than in the 1970s and 80s.
It’s natural to want to spend more when the economy grows and people feel optimistic about the future. But this might leave many households more exposed than they realize.