Best personal finance tip in this recession? Say “good bye, Amazon” and “hello, Vanguard".
This pandemic could be a once-in-a-lifetime break in your spending habits, and a breakthrough for your saving habits.
If we're spending less on stuff we don't need, that's a good thing.
Teresa Ghilarducci
As people hunkered down, spending fell drastically on restaurants, hotels and airfares. Sales of clothes and shoes plunged 90 per cent in the US, for example. I am not surprised. I don’t know of anyone working at home who used up any shoe leather or wore out a pair of trousers.
If we’re spending less on stuff we don’t need, that’s a good thing. Electronics, appliances, sporting goods, home furniture and new cars are “Veblen” goods – named after the early 20th century economist – which a person usually buys to establish their status and induce envy in others. But these purchases have been shown to produce very little long-lasting satisfaction to the purchaser.
Saving more right now could even help you break an addictive cycle: work by neurobiologist Dan Nettle, and sociologist Juliet Schor shows that buying creates its own addictive cycle of stimulus, reward and dissatisfaction.
And indeed, some have managed to save during this strange time. The saving rate in the US, for example, increased to 33 per cent in April from 8.2 per cent in February, the highest rate in recorded economic history. It was lower but still quite high in May, at 23.2 per cent.
My advice? Turn this odd development into your personal advantage. Saving in a recession is a good idea for two reasons: one, you’ll need the money for retirement; and two, saving now means you can get a good deal on assets that may be below market value.
For Americans, funnelling what they can into their retirement savings can help make up for any money they may have lost if, during this crisis, their employer stopped contributing to their 401(k) – a US company-sponsored retirement account that employees can contribute to. About 12 per cent of US employers say they’ve cut such contributions already, and another 23 per cent say they may do so later this year. “Contribution holidays” such as these can really hurt someone's retirement security.
Say you planned on saving 10 per cent of pay for retirement for 36 years, including your employer’s contribution. But midcareer, one of your employers skips a year. The consequence is that your retirement savings at age 65 will be 5 per cent less. Perhaps it happens again, and two of your employers take contribution holidays during your career. Your retirement income is now down a permanent 10 per cent. The same logic holds if you’ve had a period of unemployment – and such gaps are not uncommon for someone going through two or three recessions in a lifetime. If you’ve managed to save during this time, you can make up for those gaps now.
A second reason for saving during a recession is that investing means you’re doing what the rich do in recessions. Asset values – stocks, bonds, property – are still lower than they were in February – making a recession a good time to buy for the long term. Those with cash can buy low and sell high, much later.
Usually it is, primarily, the wealthy with cash in a recession. This recession is different. All but the highest income households in the US received $1,200 (Dh4,407) stimulus cheques and $500 per child. Those with bank balances below $3,000 most likely already spent all of it – the working poor have been hit especially hard by this downturn – but those with a little more financial cushion still have a chance to save.
And indeed, the people with more income are the ones who especially dropped their spending, according to Harvard data analysed by Vox. On the other end of the spectrum, people with low incomes are the ones who especially saw their income increase, thanks to federal stimulus and unemployment benefits that amount to an extra $2,400 per month.
All this means that for many people, if not quite all, this odd recession provides an opportunity to save for retirement, or at the very least create a cash cushion. Cash will be essential as we’ll likely see another economic dip if businesses close again due to new waves of Covid-19 cases, especially if Congress doesn’t extend income supplements to families and small businesses.
In an otherwise dark recession, a chance to build savings is a bright spot.
Teresa Ghilarducci is the Schwartz professor of economics at the New School for Social Research and the co-author of Rescuing Retirement
* Bloomberg