Save First and Don’t Borrow

by | May 31, 2010 | Cash Flow, Healthy Money Relationships, The Economy, Weekly Column | 1 comment

So much for the silver lining. Most of my financial planning peers and I hoped the upside of the worst recession since the Great Depression of the 1930’s would be a newfound fervor to save.

Not exactly. The economic crisis of 2008 apparently didn’t last long enough to create significant change in attitudes about personal saving. The amount Americans save out of their paychecks was almost zero at the peak of the credit bubble. Near the bottom of the recession it rose to 6.4%. In April, it fell to 2.7%, its lowest level since the crisis began in the fall of 2008.

I’ve argued that the economic crisis of 2008 was largely caused by Americans’ inability in recent years to save. In the early 1980’s the US national savings rate was around 10% of income. It has fallen steadily since then. Governmental policy changes in the late 90’s made borrowing even easier. Many lenders and investment banks abetted consumers in their hunger for more goods and services they couldn’t afford. As a result, our national savings rate dropped to just 0.8% in April 2008.

Inevitably, as in all credit bubbles, the house of cards collapsed. The economy went into a tailspin as lenders turned off the credit spigot, consumers slashed spending, millions lost their jobs, and many consumers defaulted on their debt obligations.

The US government decided the way to fight the necessary purging of bad consumer loans from the economy was to spend even more by borrowing and raising taxes. As a result, the US has seen its debt balloon from 64% of GDP in 2006 to an estimated 94% in 2010. Most economists predict that the government’s stratospheric increase in borrowing, while perhaps helping mitigate the blow in the short term, has guaranteed a sputtering and lethargic economy for years to come. One economist I recently spoke with shocked me when he predicted Greece’s debt problem will be easier to fix than America’s.

According to almost every prediction I read, we are in for a rough road for the next 10 to 20 years. Americans should expect to pay higher taxes and see a lower standard of living.

To survive, you will need to internalize and practice two simple economic principles. The first is: to build wealth you must develop the skill of saving. To save or invest,you (whether an individual, corporation, association, or government entity) must spend less than you make.

The second principle is: don’t borrow for consumer expenses. To quote my father’s wise financial advice: “It’s impossible to go bankrupt if you don’t owe anybody anything.” This means cut up the credit cards, don’t finance furniture or cars, and don’t borrow to fund your education.

As simple as these economic rules may seem, practicing them voluntarily is incredibly difficult for most people and organizations. Instead, many people (including elected officials worldwide) seem to ignore these principles until forced by the market to comply with them. That is when the lenders cut off your lending or you lose your job and can no longer make the payments on your debt. That is when the spending spree comes to its inevitable and painful end.

So, what can you do? First, don’t follow your neighbor or the example of most state and federal governments. Increase your savings, plan ahead for “unexpected” expenses like car and home repairs, and build a substantial emergency savings account for genuine crises like a job loss, a sudden death, or a natural disaster. Choose to live frugally now instead of waiting for an economic crisis to force you into painful, involuntary frugality later.

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