Money Market Accounts Can Help Build Your Savings Rate During the Next Expansion
September 28, 2009
Savings Rate Adjustments for Economic Recovery
With the Federal Reserve offering cautious optimism about the U.S. economy, this is a good time for you to rethink your savings strategy.
If you are like most Americans, your savings rate tends to go down in times of plenty and rise in lean times. Humans--or at least the average American--may be the only animals that follow this pattern. The next time around, you might be wise to take a cue from nature and do your storing up during economic expansions, so you have more to draw from during recessions.
Savings Rate and Economic Cycles
In theory, it should be easier to save when the economy is booming and incomes are high. By the same logic, when times are tight, you'd think there would be little room in the budget for savings. As it happens, though, the US savings rate posted record highs for the decade from the last quarter of 2008 through the first half of 2009.
Why might this be? In part, the reason is that psychology gets in the way of logic. When times are good, people see less reason to save. They don't see any setbacks on the horizon, and they expect to be making more money next year than this year--without thinking about the inevitable future downturn. In contrast, these same people tend to "get religion" during a downturn. They not only aren't so confident about making more money next year, but they also start to fear for their job security. This is when they tighten their belts and start to put some money aside, just in case things get worse.
Of course, there is a chicken-and-egg relationship between this behavior and the economic cycle. The "let the good times roll" attitude during economic expansions helps further fuel those expansions. On the other hand, when a recession causes consumers to shop less, it only further slows economic activity.
This behavior suggests that people forget that the economy is cyclical. During expansions, they see nothing but a straight line upward, and the opposite during recessions. Apply a little logic to the situation, and it seems better to acknowledge that both good and bad times eventually come to an end. You may not be able to predict when the economy will turn next, but you can be confident it will come eventually.
What this means, then, is that there's no time like an expansion for building up your savings rate. This will give you some reserve to draw against during the next recession. This practice doesn't just help you: if more people took this approach, the peaks and valleys of the economic cycle would be less extreme. (Moderating down cycles is what the government is trying to do when it increases fiscal spending in recessions.)
Money Market Accounts and Cyclical Savings
Money market accounts may be the ideal place to build up a cyclical savings cushion. Money market accounts are more savings-oriented and generally offer better rates than checking accounts, while providing more accessibility than savings accounts should you have to draw on your reserves. The main thing to remember is that money market accounts can do the most good if you build them up as the economy improves.
Source:
Fed: Economy has improved, challenges remain • Sep 09, 2009 • CNN money: http://money.cnn.com/2009/09/09/news/economy/Fed_beige_book.reut/index.htm?postversion=2009090914
Bureau of Economic Analysis: Personal Saving Rate • Aug 27, 2009 • http://www.bea.gov/briefrm/saving.htm
