Chris Farrell: What's your household's margin of safety?
- Article by: CHRIS FARRELL
- August 4, 2012 - 5:52 PM
The economy is sluggish. The pace of U.S. growth is now largely hostage to the outcome of the next round of Europe's never-ending euro crisis, which has moved from peripheral nations like Greece and Portugal to the far larger economies of Spain and Italy.
Still, I want to point out signs of a positive trend: American households are slowly repairing their finances. For example, the Bureau of Economic Analysis recently reported that the personal savings rate rose in May to 4.4 percent, up from 4.0 percent in April. The figure is well above its low of 1 percent reached in April 2005. In recent years it looks as if the personal savings rate has returned to the level that held for much of the 1990s.
Households also are reducing their debts, although much of the decline comes from foreclosures, credit card defaults, and other money traumas. Nevertheless, the Federal Reserve's financial services ratio -- a broad measure of debt payments to disposable personal income -- is down by more than 15 percent since hitting a peak in the third quarter of 2007. According to calculations by consultants at McKinsey & Co., after looking into previous credit crises here and abroad, U.S. households should return to historically reasonable debt levels by mid-2013.
Of course, the pressure is on to do even better when it comes to boosting savings and reducing debt. Yet it's remarkable how well people are doing at shoring up their finances considering the high unemployment and underemployment of the past five years. (In case you don't recall, the Great Recession ended 38 months ago. It sure doesn't feel like it.) Nothing on the economic horizon suggests that a majority of workers will take home a bigger slice of the economic pie anytime soon. Worker wages and family income growth will be severely constrained for the next several years at least.
On the level of managing personal finances, people should stay the course. Considering all the uncertainty in the economy, I would keep focusing on building up savings. It's a hedge against trouble. Whenever possible I would put money into federally insured savings accounts at your bank or credit union. Of course, in this interest-rate environment we'd all like to make more money on our safe savings. It's more important to preserve its value at the moment. In essence, think of your emergency savings fund as an insurance policy, not an investment.
I want to broaden this perspective a bit. The key idea is to manage household finances with a "margin of safety." A healthy financial buffer offers shelter against terrifying downturns in the economy and upheavals in the financial markets. A margin of safety is a money cushion against inevitable setbacks, such as a layoff, a pay cut or illness.
However, a margin of money safety involves much more than protection against emergencies. It allows for sensible risk-taking over a lifetime. Savings lets us pursue intriguing opportunities when they come along, to take risks that might lead to a more satisfying career, to embrace changes in our lives that could lead to greater happiness.
Safety and opportunity, like risk and return, are two sides of the margin-of-safety coin. When the economy finally does gain some genuine upward momentum, I think a lot of people will find that they're in a position to take greater control over their lives.
Chris Farrell is economics editor for "Marketplace Money." His e-mail address is firstname.lastname@example.org.
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