Financial advisors tell us to save money for various reasons – save for an emergency fund, save up for a down payment on your home, save for retirement, save for your children's college educations – but is it possible for savings to go too far, and does it matter how you save?
Recessions tend to breed more fiscal conservatism, and the past recession is no exception to that rule. Many Americans were forced to be more careful with their cash. Those cautious habits appear to be sticking.
Data from the Federal Deposit Insurance Corporation (FDIC) shows Americans are increasing their cash reserves as the economy continues to improve slowly. Total bank deposits in the U.S. reached $10.7 trillion in 2016, maintaining a steady growth trend in cash reserves.
Combined with the fact that wages are staying relatively stagnant and consumer spending is also relatively flat, the increase in cash reserves is not a good sign for the economy. America's economy is approximately 70% driven by consumer spending. When consumers are hesitant to spend, the overall economy suffers.
Retirees are especially prone to hoarding cash, according to a study by financial planning software company United Income. Retirement is when you are supposed to spend the amount that you have saved, but the study found that the average American above age sixty actually reduces their spending by 2.5% per year.
Certainly, the Great Recession is fresh in the minds of recent retirees. Having watched the misery of overextending consumers taking a beating in the housing market and in stocks, retirees may fear a repeat performance just when they can least afford to take a financial hit.
Other motivation for retirees to stay tight-fisted include skyrocketing medical costs and uncertainty about health care options, fear about not being able to live their preferred lifestyle for the rest of their lives, and simply not realizing how much they can safely spend.
On a personal scale, it's important to balance your assets between liquid accounts like checking/savings accounts and longer-term investments such as stocks and bonds. Inflation eats away at the value of your cash, and it can be nearly impossible to find a checking or savings account that could keep up with today's unusually low inflation rate, much less the high inflation rates of the 1970s. Most brick-and-mortar bank accounts provide from 0.01% to 0.05% interest, slightly better than stuffing your money in your mattress.
Take the advice of Warren Buffett, who points out that while volatility of stocks is greater over a short period of time, cash is a riskier investment over the long term than stocks. Stocks consistently outperform all other methods of investment in the long run, while cash is guaranteed to be subject to inflation that eats away at future purchasing power.
Consider that from 1802 to 2012, the long-term real return (accounting for inflation) of stocks is approximately 6.6%. Bonds only returned 3.6%, gold returned 0.7%, and cash produced a negative return.
How much cash should you retain? Generally, an emergency fund should cover anywhere from three to six months of living expenses. Your remaining investments such as retirement funds should be in other vehicles that propel growth. Balance those investments according to the relevant risk factors in your life, such as how close you are to retirement and how many other large expenses you are likely to incur. Let the free Retirement Planner by MoneyTips help you calculate when you can retire without jeopardizing your lifestyle.
Do not let fear steer you into hoarding more cash than you need. Map out your long-term needs, and seek professional financial assistance if necessary to help you do so. Your mattress isn't big enough to handle all of your financial responsibilities.