Why Saving Matters
As the R-word, recession, (BusinessWeek, 2/11/08) creeps into ever more conversations, Ronald Wilcox is trumpeting the value of a penny saved and a realistic outlook.
A professor of business administration at University of Virginia's Darden Graduate School of Business Administration, he argues that Americans need to start saving more money to improve the long-term economic outlook of the country. In his upcoming book, Whatever Happened to Thrift (Yale University Press), due out in June, Wilcox presents the psychology of money and the mistakes people make with it. He also calls for people to spend less and save more.
"Students who can understand the psychology of money, who read broadly about how people think about money, how people think about the relationship between money and their lives, and are able to help people save more, are going to be very influential," says Wilcox, who recently spoke with BusinessWeek reporter Francesca Di Meglio. Here are edited excerpts of their conversation:
What motivated you to write the book?
Households in the U.S. save less of their income than anyone in the developed world. I wanted to explore why that was the case and if there was anything we could do about it. That's interested me for a long time. Partly that interest comes from observing different people in life. Some people spend a lot, more than they have. Some people are very thrifty, and I wonder what's the difference between those kinds of people. Why overall in the U.S. economy do we find so many people who spend more than they make?
How do you think we ended up at this point where American families are spending more than they make?
Americans have saved less than most developed nations for a long time, even pre-World War II. It's not like we've ever been a nation of savers. There are famous examples of people who are prominent in American history—Thomas Jefferson being one— who were always in debt. Part of that is [because of] the history of the country. We are a country of optimists. When you're optimistic you tend not to save because you think tomorrow is going to be better than today.
I do think certain things have changed in the world. One is that real interest rates are low. It's cheap to borrow money if you're in the U.S. You don't get a high return if you save money. Part of the reason is that many countries' citizens who do save more money than Americans, in essence, through their governments, pour their money into the U.S. because we're a safe place to hold money. We don't have coups. When all that money flows in, it keeps our interest rates artificially low, so our domestic citizens both don't see the returns on savings and can borrow money cheaply in capital markets. It's not that we're morally bad or worse than people in other countries. We're optimistic about the future, and we have the ability to go into debt in ways that lots of other people don't.
Do you think the fact that people spend more than they have and don't save is why we're in trouble now?
I think that is true in the housing market, where people probably spent too much money on their houses. When the housing market is declining as it is right now, they don't have additional savings to cushion their ability to go out and buy things that they would like or need. The lack of savings probably is exacerbating the current economic downturn. I think it will exacerbate it in the future. I don't think it's the primary cause, however.
Overexuberant lending. I lay it at the feet both of individuals who borrowed too much money and overexuberant lenders.
Would it help our economy if more people saved?
Yes, it would. It would not help in the short term. The government is exhorting us to spend the tax rebates that are going out now. In the short term, the economy would be better off if people spent more money. But that is a short-term solution. In the long term, we would be better off if people had more money in savings, so when there are economic downturns, they could then tap into some of that savings to buy the things they need and want. Part of the problem is that in an economic downturn, when people have lower incomes or they lose their job or make a little less, there's no reserve for them to tap into.
What do you say about the government pushing for people to spend?
It's an understandable, political decision. Politicians want the economy to recover rapidly because they want to remain in office. [Spending] just kicks the problem down the road. I don't think it is good policy to exhort everybody to spend their check. It would be better for us if people, particularly those who have saved very little, took that rebate check and put it into their savings. We'd be better off long term.
What advice do you have for people on saving money?
There are some ways to save money that are easier than others. One is to make a decision now that you are going to save more when you get your next raise. That's a plan called the Save More Tomorrow Plan by Richard Thaler. You go to your human resources department and say: "At the time of my next raise, I want to allocate a certain percentage of that raise to my 401(k) plan." The benefit is that you never see your paycheck go down, and it's a lot easier in this kind of environment than going cold turkey and saving more today.
What would you say to a young person today about how they should look at their salary and personal finances in general?
A young person has to understand that few companies are going to provide for your retirement savings. The second thing is that compound interest is a very hard concept for people to grasp. The earlier you start saving, the better. And I recommend [saving] 10% to 15% of your income. You just say this is like a tax that I impose on myself. That's the tax I have to pay to myself to make it possible to stop working at some point.
Do you think that a lot of older people will have to continue working?
I do think older people will continue to work. I might add parenthetically that that's not all bad. A part-time job keeps older people social and happier. I think people will have to work a little bit longer. There's an emerging financial instrument, reverse mortgages, where you tap into the equity of your home and borrow from it. That's a small product right now, but I suspect it will get a lot larger because people will need to do that to finance their retirement.
How grave is the situation that we're facing when it comes to savings and the future of our own finances?
I don't want to say we should become pessimists. But I think we should become realists. It is unlikely that wages and the money we earn in the U.S. are going to go up dramatically in the next couple of decades. That's true at the aggregate level. On average, it's true at the personal level as well. Individuals need to be realistic about how much more money they're going to be making over time. There's no magic bullet to that. Most mentally healthy people—even non-Americans—are optimistic. But when it comes to money, you need a little bit of realistic pessimism about your future to adequately determine how much you need to save.
Do you think we're in a recession? What will the future bring?
Anyone who tells you that he or she knows is a fool. I'm pessimistic about that unfortunately. I think we're in a recession. Unlike other recessions, we don't have the stock of savings to fall back on. Individuals are tapped out. Since consumer spending is the thing that brings us out of a recession, I'm pessimistic about our ability to pull ourselves out of this recession any time soon. Savings rates now look about the same as during the Great Depression. That doesn't bode well for our individual ability to pull ourselves out quickly. [Many are saying], "I can't spend this money, I can't spend this check the government is sending me, I need to save some of it." If that's the case, we may have to go through a prolonged period of economic downturn.