There are plenty of positives that have come out of the coronavirus pandemic: better health, less pollution, more time with family, an acceleration in the work from home trend, and the chance to buy stocks at large discounts, to name a few. The U.S. personal saving rate could be the most positive of them all.
Thanks to the lockdowns, the U.S. personal saving rate surged to an incredible 33% in April! Although it has gradually faded throughout the year as confidence resumes, a 33% saving rate is still very impressive. It means that when Americans need to save, we will.
The personal saving rate is defined as savings as a share of personal disposable income. Personal disposable income is defined as income less taxes.
If your income stays the same, the higher your personal saving rate, the stronger your household balance sheet. The stronger your household balance sheet, the more financially secure you will feel. The more you save, the quicker you will achieve financial independence. Love it!
Our household plan has been to cut our spending by 32%. The cut is to match the 32% decline in the stock market from peak to trough. If the stock market and our income rebounds, we will have increased our cash flow and our wealth. If the stock market and our income stay depressed, then we will have continued to protect our financial freedom.
As evidenced by the latest personal saving rate data, I’m pleased to see tens of millions of Americans do the same.
Below is the historical personal saving rate chart by the Bureau of Economic Analysis. As you can see from the chart, today’s personal saving rate of 33% has far surpassed the historical high of ~17% in 1975 and more recently, ~12% in 2013.
1960 – 10%
1965 – 12%
1970 – 11%
1975 – 17%
1980 – 10%
1985 – 7%
1990 – 7%
1995 – 6%
2000 – 4.5%
2005 – 2%
2010 – 5.5%
2015 – 7%
2021 – 33%
What’s interesting about the 33% personal saving rate in 2021 is that it comes at a time when the average money market interest rate is close to an all-time low. Americans have been so freaked out by the coronavirus, the forced lockdowns, the mass unemployment, and the sell-off in the stock market that they’d happily earn close to nothing rather than lose money.
From 1970 to 1975, it was understandable to save between 10% – 17% of personal income. The inflation rate back then was around 8% – 9%. OPEC placed an embargo on oil exports to the U.S. and inflation shot higher. In comparison, the average inflate rate per year between 1975 and 2021 has been closer to 3.5%. Today, the inflation rate is under 2%.
In other words, saving money back in the 70s yielded a much higher savings interest rate than it does today because the Fed Funds rate, inflation, and the 10-year bond rate were also much higher.
In 1974, the Fed Funds rate was between 9% – 13% and the 10-year Treasury interest rate was between 7% – 8%.
Today, with the Fed Funds rate at between 0% – 0.25% and the 10-year bond yield under 1%, an online savings rate above 1% is relatively pretty good. Meanwhile, earning a guaranteed 1-1.3% on your savings is much better than potentially losing 30%+ in a bear market.
Everything is relatively in finance. In order to achieve financial independence sooner, you must do at least one of the following:
In other words, with the average U.S. saving rate at 33%, I challenge you to double your savings rate to 66%!
Since the beginning of ONIG Financial Blog in 2009, I’ve encouraged readers to aim to save 50% of your after-tax income. With a 50% saving rate, every year you work will be one year of living expenses saved. After 20 years of saving and investing 50%, you will likely have way more than 20 years of living expenses covered due to market returns.
For example, let’s say you make $100,000 after-tax a year and save $50,000 a year for 20 years. If you earn a feasible 6.3% compound annual return over the 20-year period, you will end up with $2,019,000. Now let’s assume your average living expenses rise from $50,000 to $65,000 in 20 years due to inflation.
After 20 years of saving 50% of your income and earning a 6.3% compound annual return, your $2,019,000 portfolio will provide for 31 years of living expenses. You are practically set for life given your portfolio should continue to return something and you will be eligible for Social Security.
If you were to somehow keep your living expenses flat at $50,000 a year because you paid off your mortgage or something similar, then you would now have 40 years of living expenses.
Below is an easy savings guideline that shows how many years you’ll need to work before you can retire based on your personal saving rate. The minimum recommended saving rate is 20%.
I’ve tested the chart against my own experience. I saved roughly 60% of my after-tax income on average every year from 1999 – 2012 and was able to leave work for good after 13 years. I’m absolutely sure that even if my savings rate was lowered to 50%, I would have still left after 18 years. This reason is because I was saving a higher absolute dollar amount during the last five years of my career.
It was still scary to leave a well-paying job, especially after so long you get used to saving aggressively. However, if everybody can also negotiate a severance package before they leave, the extra income will provide a lot more courage to say goodbye to work.
Another easy personal saving objective is to accumulate a certain multiple of your average income or current income by age. As you get older, your savings or net worth should equate to a higher and higher multiple of your current earnings.
For example, by 30, you should have at least 2X your income saved. By 40, you should have 10X your income saved, and so forth. Your ultimate goal should be to try and save at least 20X your current or average income before considering calling it quits.
If you can save at least 20X of your current income at age 40, then it’s probably safe to take things down a notch. You may not want to fully retire, but at least you can take a nice long sabbatical and not have to worry about the financial repercussions.
Many people will argue that it’s better to have a saving goal based on a multiple of your annual expenses. This is absolutely a fine way to go. However, I like basing a savings target on 20X income because it is more challenging, especially the more you make.
By basing your saving multiple on your annual expenses, you can easily “cheat” your way into reaching your 20X savings goal by cutting down expenses to the max. It is human nature to take shortcuts, especially with difficult goals.
However, “cheating” your way to financial independence may rob you of a more fulfilling journey. For example, to try and achieve financial independence sooner, you might:
Challenge yourself to save 20X your income instead of 25X or more of your annual expenses based on the 4% rule. You’ll end up more motivated, more excited, and wealthier.
Let’s be frank. We all knew a 30%+ U.S. personal saving rate was unsustainable. The personal saving rate already dipped to 23.2% in May and is now down to around 14% in September. It will likely continue to go lower as the economy opens up.
Americans have an insatiable appetite to consume almost all of their income each month. As investors, we need Americans to consume like there’s no tomorrow again to get corporate earnings back up.
Based on the historical trend, the average U.S. personal savings rate will likely come back down below 10% by 2021. I anticipate the average U.S. personal savings rate will range between 5% – 10% for the next 20 years. I also believe more Americans will be using their savings to buy homes in 2021+.
Don’t let the inevitable decline in the U.S. personal saving rate distract you from trying to consistently save 50% of your after-tax income. The alternative is to save 20X your annual gross income. The longer you can hold strong as the rest of America fades, the relatively wealthier you will become.
I promise you that if you save at least 50% of your after-tax income a year for 10 years, you will surprise yourself and start feeling a new sense of freedom. You will love this feeling of freedom so much so that you will want to force yourself to save even more!
Get your personal saving rate up. You won’t regret it.