When someone asks me to give them one personal finance metric to really focus on that matters more than any other, there is no hesitation in my reply: “personal savings rate“. No matter which way you slice it, everything in personal finance boils down to what you earn, what you spend, and the relationship between those two numbers (your personal savings rate). Your personal savings rate is your total savings (or debt) divided by (take-home income + work retirement contributions). It is typically referenced as an annual number.
The goal, with this ratio, should be to drive it as high as you possibly can. And the sooner you do so, the better off you will be. Why?
- If your personal savings rate is negative, you are spending more than you earn. This means you are either accruing new debt (and paying interest on it) or you are cutting in to the tiny bit of net worth that you have accumulated. Despite all of your potentially stressful and painstaking labor, your monetary existence is resulting in other people getting richer and you getting poorer. Sobering, isn’t it?
- If your personal savings rate is zero, you are essentially working with zero gains to show for your efforts. You are not getting poorer, but you’re not getting any richer either. Time is passing you by.
- If your personal savings rate is positive, you are adding to your net worth. This is good, of course, and the higher the ratio, the better. A positive personal savings rate allows you to build reserves to weather inevitable setbacks, pay off suffocating debts, and save towards big financial goals like home ownership, starting a businesses, helping others, and retiring. Good stuff, right? Well, the benefits of a positive personal savings rate don’t stop there.
Compound returns on invested savings leads to significant future paybacks. Every additional dollar of personal savings today is like saving multiple additional dollars in the future.
In fact, $1 saved and invested by someone in their twenties is worth $10.06 of savings to their future 50’s self (at an average annual rate of return of 8% on investments over 30 years). Even if you factor in 2% annual inflation, you’d theoretically still have 556% of the buying power for every dollar you save and invest today, in 30 years. And you can 2X your retirement savings by starting at age 25 versus 35 from compound returns.That’s the power of compound returns.
Unfortunately, that ain’t happening for millennials (age 35 and below). We knew that the personal savings rate for Americans was bad (it has been hovering around 4% for a while). But new data shows that it’s even worse for millennials: -1.8%!
While older generations have stayed relatively flat since the Great Recession – millennials (the red line) have dipped from a high of +5%.
If you’re looking for a silver lining, there is one – millennials’ personal savings rates are still above the absolutely catastrophic negative 10-15% levels that were seen pre-recession.
Nevertheless, negative is still negative, and for those in that territory it means declining net worth (or increasing debts), zero savings to show for labor, no financial savings goals met, decreased mobility and independence, and missed opportunity for compound investment returns. You don’t get these years back, ladies and gentlemen.
What is truly sad about all of this is that it doesn’t have to be this way. If millennials (or any generation, for that matter) were to collectively trim off just a small and insignificant portion of gross consumer excess, personal savings rates could very easily be +10-20% and above. It wouldn’t even require any true sacrifice. If everyone were to shop around for better insurance rates, switch to a prepaid phone plan, avoid credit card debt, give self-powered commuting a try, take their lunch to work, cook from home more often, reduce their energy waste, and cut cable TV – we’d collectively get there. And we’d be planting the seeds for a much better future for ourselves and subsequent generations.
The punishment we are dealing to our future selves in exchange for shallow and inconsequential luxuries is alarming. Change starts with you, right now.