That’s “total saving rate” (more on that later). Economists define saving as disposable income minus consumption. “Saving” differs from “savings” – the former is the active verb for putting money aside, while the latter is the noun for the pot of wealth that has been saved.
We probably all are aware that saving rates have been falling through the floor of late, most notably in the US, where the rate hit zero, from 10% two decades before. Ironically, the present recession has brought a new frugality to those whose jobs have not already been eliminated. The saving rate in May was 6.9%, a 15 year high, and the ninth highest month since 1973.
The reasons for the slide to zero-saving are no doubt multi-fold, but we think one aspect has been a consumer, and consumption, driven society for many years. History has attached various labels to Western society – the Age of Enlightenment, the Industrial Revolution, the Dark Ages to name a few. We think that some time in the future our present era will be named the Age of Materialism.
It is a common view in Western cultures today that people should spend. Governments encourage this, to take the fiscal load off them to stimulate a distressed economy. And so, for instance, there are, on average, four credit cards issued to every man, woman and child in America.
While zero saving rates fuel today’s economy, they bring an over-heated economy and a disinterest in tomorrow. So, governments need to steer towards a middle path, and our federal government is getting into the act. The recent Budget called for more financial literacy, and a 13 member task force has just been appointed to figure out a national strategy for improving Canadian knowledge on financial issues as an essential life skill.
Keynes believed that people put very little thought into their saving decisions. He further believed that the saving function was not derived from the saving need but from income availability. He said that, given the economic concept of “propensity to save”, saving rates will increase if and when income rises. Modern research by Lusardi and Mitchell in the US, as well as others in Canada, support this thought today. Remarkably few people have “a plan”, even though it may be one of the most fundamentally important aspects of life. The importance of framing bears upon this issue – people find it easier to seek external goalposts than to establish their own. As a result, they are susceptible to societal cues which tell them how much to spend and how much to save.
So, in the absence of their own plans, people’s cues come from various places – peers, financial professionals, media, employers, governments etc. Mandatory contributions (RPPs and CPP) and benchmark savings rates (18% of earned income) are examples. Research by Thaler and Benartzi showed that people are pliable and can be coaxed into saving, and even into accelerated saving. Where a financial planner may not be able to convince people that they ought to have financial plan, at least guiding them to a saving plan that requires them to stretch is a good half-victory.
Work in behavioural finance suggests that people work with different “mental accounts“. Different pots of saving efforts are intended for different purposes – a house, a car, a new roof, vacation money, retirement money etc. Some may view this as a quirky way to approach household finance, but if it works – great!
The term “saving” actually merits some further explanation. We all likely have our own definition flash through our mind when we see the word, and it likely involves transferring some of our hard-earned cash into some savings vehicle. But how would you define this for the retiree or capitalist who doesn’t get up to go to work in the morning. Does the interest and dividend income earned, but not spent, count as the capitalist’s or retiree’s saving? Is the investment income earned and compounding in an RRSP for a work-a-day person part of saving, too? Or does behavioural finance’s “mental accounts” cause that person not to even think about this money until retirement?
We believe that there are in fact at least TWO saving metrics – “earned” and “total” and each is valid in its own right.
The first measure of saving is the more popular one implied in the media – the “sacrifice” one that economists call the propensity to save! The earned saving rate (“ESR”) is the saving put aside annually divided by annual family earned income, that being salaries, wages and self employment income (In the case of incorporated entrepreneurs, it should also include annual retained earnings before tax). Earned saving includes money put aside into “savings places”, like RRSPs, company pension plans and brokerage accounts, but may also include “saving” applied to debt reduction, eg a mortgage or line of credit. This requires some clarification—it should not include debt reduction on consumer debt, eg credit cards etc, because this is merely spreading consumptive life costs over time, not saving. We believe it should only include debt reduction on loans to acquire appreciating assets, eg real estate or investment accounts.
The second measure of saving is called total saving rate (“TSR”), which calculates a broader measure of saving divided by a broader measure of income. “Total saving” includes the earned saving above plus the investment income earned in your investment accounts (including interest and dividends and the unrealized net appreciation in those accounts over the year), but also subtracts any withdrawals from your investment accounts used to fund life costs. “Total income” includes the earned income above plus all of the investment income earned in your investment accounts (the amount just calculated in the previous sentence).
The aggregation of this information calculates your annual (“simple”) ESR and TSR. But be prepared for a surprise! In a bear market such as now, the annual return (and saving) from your investment accounts may be a negative number, meaning negative saving, and that negative amount may exceed the earned saving you are doing out of household income. As a result, it would be wise to calculate a second saving rate – long term compound – for both ESR and TSR. This will smooth out the problem with negative saving years and give you a good long term benchmark of your saving discipline.
An Excel worksheet can be set up to track your ESR and TSR over time. The following is an example, which is a composite of real-life data plus some extra assumptions.
You can see how bad stock market years (2002 and 2008) lower the simple TSR below the simple ESR. But the long term compound saving rates give a fairer measure of long term saving diligence.
These statistics should provide a simple feedback loop to counteract the human shortcomings observed by Keynes et al.
We can help you calculate your historical ESRs and TSRs if you wish. For Trivest clients, the additional data for TSRs already exist in your annual reports.
Perhaps the Age of Materialism will pass into the history books and a new era awaits definition. While the Age of Materialism had us finding reward from internal and external recognition from the things around us – the cars, the homes, the fancy vacations etc – perhaps the new era will provide such satisfaction from bragging about our “TSR”!